Credit Agencies Start to Get Heads Out Of Asses
With the collapse of Bear Stearn’s CDO hedge funds it seems the credit agencies have at last sent out late word that downgrades in mortgage structured finance are in order. Of course this has the potential for unraveling the whole mark to model edifice in one swoop . One credit agency, Fitch has been just a bit more active lately in this process, with the following representative.
June 22 (Bloomberg) — Four collateralized debt obligations worth about $3.1 billion and containing subprime mortgages from 2006, the kind that resulted in losses to two Bear Stearns Cos. hedge funds, may have their credit ratings cut by Fitch Ratings.
From Fitch:
Leverage added to the continuing surge in credit-oriented hedge fund assets could be a recipe for disaster for investors in the next market downturn, Fitch Ratings warns. The impact of hedge funds “cannot be measured simply by trading volumes,” says Fitch Managing Director Roger Merritt. “One must also consider a funds willingness to employ financial leverage and to be ‘risk takers’ by investing lower in the capital structure. That “effective leverage,” says Merritt, “is what amplifies the impact of hedge funds on the credit markets.” Even without the leverage, hedge funds have certainly made their presence felt. According to the International Monetary Fund, credited-oriented HF assets increased 600% in 2005 from five years earlier, and now account for 60% of the trading volume in the $30 trillion credit default swap market — and employ leverage of five or six times. Fitch says liquidity risk is among “the more important issues facing credit investors in the near-term,” adding that “the inherent stability of hedge funds as an investor class…is distinctly different from more traditional buy-and hold institutional investors.” As a result, in a market downturn, says Fitch, “the potential for a forced unwind of credit assets cannot be discounted, which in turn could lead to correlations that are different than historical expectations.” During a period of market stress, according to Fitch, “any such forced selling of assets would be magnified by the effect of leverage.” The ratings agency points to tight credit spreads and abundant capital as spurring even more access to funding and refinancing maturing debt. “Refinancing risky could be magnified in the next down turn,” says report co-author Eileen Fahey, a managing director at Fitch, “and credit investors need to have a robust view of liquidity sources and uses, including on- an off-balance sheet debt, upcoming maturities and contingent liquidity claims.”
The hyper-reality quote of the week has to be this delusional one from failed Brooksfield Securities.
“It wasn’t a problem with securities,” she said. “It was a problem with the margins (calls).”
Incredibly while at least Fitch acts in a Johnny Come Lately responsible manner, that hollowed, I mean hallowed institution, the Federal Reserve Bank, makes the decision to just drop Fitch altogether. Just a coincidence? Gee, who’d da thunk?
On June 18, 2007, the Federal Reserve Board stopped using Fitch Investors Service as a credit rating source. Classification as AA or A2/P2 for rate calculations and classification as Tier-1 or Tier-2 for outstanding calculations are done using Moody’s Investors Service and Standard & Poor’s.
The Fed may have to also drop Standard and Poors, as a mad scramble to catch the train seems to be on.
Standard & Poor’s Ratings Services today took various rating actions on 133 subordinate classes from 62 different transactions from 23 different issuers. We downgraded 45 classes backed by closed-end second-lien collateral. … The downgrades and CreditWatch placements reflect early signs of poor performance of the collateral backing these transactions.
Of course the Ministry of Truth’s functionaries didn’t waste much timing pulling more Milky Way gambits out their asses either. Here we see a dead fish at Merill Lynch following the Joseph Goebbels dictum of the “big lie”, suggesting that if things really got bad at Bear Stearns “somebody” would buy them out at a big premium. Talk about the sublime to the ridiculous, this one really has Alice in Wonderland, hyper-reality logic being turned on it’s head. If things get bad enough, there won’t be any credit for these stupid deals, period.
A primary Winter axiom is the revelation that the use of derivatives have allowed financial institutions to just make up prices on their securities in whatever manner suits them . The Bear Stearns experience now gives us a inkling of what’s going on under the surface on this front as well. Not only did BSC’s funds lose on toxic securities, but also on the credit derivatives used to protect (supposedly) those securities.
Then an additional bet Cioffi had made to protect his investors, using derivative contracts on ABX indexes to hedge against a decline in the subprime market, also went bad.
Finally in a reversal of the middle finger gesture to actions from the authorities, the markets in China actually tanked on mere words from a PBoC governor. To borrow from Monty Python, “Now for something completely different?”.
June 25 (Bloomberg) – China’s stocks plunged by the most in three weeks after central bank Governor Zhou Xiaochuan said shares may be overvalued and he doesn’t rule out raising interest rates.
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