Tuesday, March 11, 2008

Third Wave - The End of Risk Taking


Recession fears -> credit spreads widen, lower dollar -> margin calls, higher prices -> deleveraging, labor shedding -> more recession fears -> credit spreads widen, lower dollar -> de leveraging, labor shedding -> margin calls ... the last "strong hands".

How much does this affect the real economy?

No one knows, but the 'third wave' of this crisis will be the most grim, I suspect.

Wall Street has problems moving 'in reverse' (shrinking, let alone shrinking abruptly) and soaring borrowing costs for companies is yet another cost that will squeeze profits in the near-term.

"Investment grade credit was the area of the market that was levered the most, 10 to 15 times," said Mark Kiesel, portfolio manager at Pimco. "It is now the cheapest as investors are deleveraging their positions."

Yesterday, the CDX index for US investment grade companies surged 15 basis points to a record wide level of 193bp. The CDX has risen from between 30bp and 40bp a year ago.

In Europe the iTraxx index of investment grade corporate debt was trading at a record 157bp, up from 146bp on Friday. On a relative basis, both these measures of investment grade credit risk have widened more than crossover credit, which is mainly junk-rated. -FT

Rock-bottom, for some, is at ... all-the-way, frankly:

In the credit crisis, spreads have widened dramatically, reducing the value of the leveraged CDS contracts that CPDOs hold. The products typically reach automatic unwind triggers if their net asset value falls by more than 90 percent.

At least one CPDO that invested in financial CDS has hit its cash-out trigger. [!!!] As spreads have widened, traders in the CDS market have expressed concerns that others may be forced to unwind.

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