Some Closing Comments for October 09 2008

October 9th, 2008 4:43 pm | by John Jansen |

Prices of Treasury coupon securities plummeted today as the weight of supply and anticipated supply weighed on the market. Deleveraging continued and the lack of balance sheet motivated selling. Traders report that many relative value strategies have blown up and the volatile nature of the market place has forced many to the sidelines.For example, one can follow a butterfly trade involving the 5year/7 year/10 year portion of the Treasury curve. One trader noted that the spread traded at plus 13 basis points less than a month ago. The 7 year portion of the curve approximates the bond contract. With much of the Treasury market in fail status, mortgage desks began hedging their detritus with the note contract. That began the cheapening process of the sector.

The Treasury delivered a body blow to the sector yesterday with the issuance of $40 billion of paper in that sector. When I spoke with a trader a little while ago the 7 year was now 100 basis points cheap to the wings of that butterfly.

Lacking balance sheet there are no firms or proprietary capability to step in and warehouse securities and the market sinks into a dysfunctional fetal position. That is the current state of the bond market.

Since I began this closing commentary piece for this day the stock market went over the edge with another very steep decline. I searched for a story or a rationale and I think that the rationale is in the credit markets.

IBM raised $4 billion today with the sale of 5 year, 10 year and 30 year bonds. I will relate the story of the bond in the 10 year sector.

I shall begin with the IBM bond which matures in 2017, which is one year shy of the bond that the company offered today. It is not exactly the same but we can compare. That bond traded one month ago at a spread of about 170 basis points to the 10 year Treasury. Yesterday, a salesman with whom I converse, (and friend of the blog) sold some to a customer of his at T+265 basis points.

Today when IBM offers the new 10 year bond the market forced that gilt edged untainted by the credit crisis technology company to pay T+388 basis points. It was over 120 basis points cheaper than a comparable bond traded yesterday. That is a sign to me that the credit markets are in the direst state and that funding is drying up for corporate America.

Can you imagine the result if a financial company other than JPMorgan or Wells Fargo visited the market and tried to raise funds? There would be no takers for a host of large cap financial names or smaller regional bank names.

I have said this before and risk redundancy but more and more it seems likely that the resolution of this crisis will be an historic financial calamity. Each and every step which central banks and regulators have taken to resolve the crisis has been met with failure. In the beginning, the steps would produce some brief stability. In the last several days, the US Congress (belatedly) passed a bailout bill, the Federal Reserve has guaranteed commercial paper and in unprecedented coordination central banks around the globe slash base lending rates. Listen to the markets respond.

The market scoffs as Libor rises, stocks plummet and IBM is forced to pay usurious rates to borrow. There is no stability and no hiatus from the pain. It continues unabated in spite of the best efforts of dedicated people to solve it.

We are in the midst of an unfolding debacle. It is happening about us. I am not sure how or when it ends, but the end, when it arrives, will radically alter the way we live for a long time.

Whoever wins the US election and takes office in January will need prayers and divine intervention.

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  1. 16 Responses to “Some Closing Comments for October 09 2008”

  2. By SS on Oct 9, 2008 | Reply

    Well that sucks — understatement of the year probably.

    We’ll see how LEH settles out tomorrow. That should clear the air a bit. Also, hedge funds are doing their liquidations for redemptions right now. Finally, the equity markets let the short sellers back in and what a surprise them markets got nuked. That’s got to be exacerbated by all the equities the FED picked up for collateral. I’d hate to see the MTM on that stuff today. If there’s a lot of it, there might be some forced liquidations in the AM.

  3. By fatbrick on Oct 9, 2008 | Reply

    Nationalize the banking industry.

    Ok, what time will they auction the LEH CDS tomorrow? Given what happened to IBM, I guess it would not be pretty.

  4. By Al on Oct 9, 2008 | Reply

    I think if Dubya could have at least a bit of intelligence or shame, he would fire Bernanke Paulson and Co right away. Because now it’s about trust/confidence, and competency for obvious reasons.

  5. By Hang Paulson on Oct 9, 2008 | Reply

    Wish we could eventually see the Federal Reserve placed in the ash heap of history with the rest of the central planners.

  6. By John Jansen on Oct 9, 2008 | Reply

    He could fire Paulson. I am not sure how you remove a Federal Reserve governor. Moral turpitude. Maybe he lied on his application for helicopter pilot license.

  7. By Michael Oliphant on Oct 9, 2008 | Reply

    SS. I gotta take issue with your remarks about the shorts. The short ban was monumental stupidity resulting no bids. How can you sell when there are no bids. Shorts cover all the time creating bids. This is just one more example of how the administration has cut off their nose to spite their face. HUGE blunder!

  8. By Danny on Oct 9, 2008 | Reply

    Nice post, but would have been clearer in plain English, not banker jargon.

  9. By SS on Oct 10, 2008 | Reply

    Michael,

    I agree in a general way about shorting. The problem here is that allowing the markets to clear looks to be destroying them pell mell. I’ve argued for the last few months that a controlled implosion was preferable to an uncontrolled one. I still believe this and have my fingers crossed that we don’t get to see a full collapse.

    Shorts have no incentive to cover until buyers in size show up to put in a bottom and reverse the trend. That’s not going to happen until real value is seen. What number is that and what ends up being collateral damage along the way? I’m sure we’ll find out. I just hope the price of getting there faster isn’t the whole system…

  10. By Michael Oliphant on Oct 10, 2008 | Reply

    Sorry. When you make a stock trade as buyer you make a bid – a market order is only a quasi bid but usually one enters an order to buy at xx$/share. That’s your bid.

    Shorts sell stock they don’t own to start their transaction and buy it to close. They hope the stock goes down because when they sold they received $$ for the sale and they want to buy the stock back for less. That’s the key. They have to buy it back. There is still two sides to the transaction.

    When shorts were taken out of the equation they eliminated all those shorts who would have otherwise bought back their stocks because they either felt they made a decent profit, or they

  11. By Michael Oliphant on Oct 10, 2008 | Reply

    Oops. or they… get scared that they are going to take a loss in which case they buy back to limit losses.

  12. By Michael Oliphant on Oct 10, 2008 | Reply

    SS. Here’s a question for you. On which day did the Dow experience the largest gain in history? Answer. About a week or two ago, can’t remember exactly but the market took off like a bat out of hell and shorts got squeezed big time. Eliminating shorts also eliminated any rallies such as that.

    Perhaps, in the big picture, your argument has some merit. However, shorts pick targets. Many will short a stock and immediately put in a buy order at their target price and buy back once the price hits. Well, guess what? Those are gone.

    I ask you… who is more prone to buy in a falling market? Someone who just got their ass kicked in their last stock purchase or someone who has already made a tidy profit on their short?

    I stick with my position. Big mistake. Very, very big mistake.

  13. By Kevin on Oct 10, 2008 | Reply

    First, I enjoy your commentary very much and contrary to the above criticism, the level of jargon seems appropriate given the material.

    Second, you stated that the 10 year IBM paper was sold to yield +388 over a 10 year Treasury that trades around 3.75%. That would equate to a 7.63% yield.

    Now, think about which side of this spread is mispriced and why. High grade corporate borrowers have issued paper at this absolute level before in even more sanguine times. This deal was not priced off of Treasuries. That is just the way you chose to analyze it. So the question is: How was the IBM paper price/yield determined? What absolute level of return would you demand in the current state of circumstances? Given that it seems to be a buyers market(as much so as I have seen), the pig in me might ask for even more.

    As an alternative, investors may be regarding the exceptionally high earnings yields offered to equity investors on the NYSE.

  14. By awahdacksesse on Nov 17, 2008 | Reply

    Appearances are deceitful ;)

  15. By EMBOBBYWASE on Nov 19, 2008 | Reply

    Reason why is great to be a gay :P
    If you retain water, it’s in a canteen. Joke ;)

  16. By Star on Jan 22, 2009 | Reply

    what a real story..

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