Credit Markets, Warren Buffet and the Lehman Settlement
Oct 17, 2008
Posted by Jody Eisenman | Filed under crisis
As I write this on Friday afternoon, the Dow Jones is up about 200 points. The TED spread, which is a good measure of lending willingness has dropped a full point off its’ high last week from 457 to 357 basis points. Warren Buffet, head of Berkshire Hathaway and one of America’s most successful investors believes that now is a great time to buy stocks. Have we bottomed here?
Maybe, but I wouldn’t bet my last dollar on it. LIBOR remains very high at 4.41 for 6 months. As a measure of comparison, 6 month t-bills yield around .43. So, there is almost a 400 basis point difference between the two, which is still incredibly high. In addition, consumer spending is dropping, unemployment is increasing, and the credit markets will probably take some time to adjust. In other words, even if credit becomes more available, it’s not like every company and municipality that needs cash desperately is going to get it immediately. Thus, I still believe that many of the weaker companies (especially financial ones) may still face eventual bankruptcy. Hardly a day doesn’t go by where another large hedge fund announces that they are facing huge redemptions and/or liquidation. There is clearly still a lot of skittishness in the financial world. Any new event could well trigger another huge selloff. In regards to this, readers should be aware of the Lehman settlement.
The Credit Default Market is estimated to be in excess of $50 trillion. The Lehman Credit Default Swap (CDS) settlement will take place this Tuesday, Oct 21 in the amount of approximately $360 billion. This sounds like a staggering number, and it is, but it is also widely believed that many of these CDS were hedged. In other words, the institution that was on the hook for say $10 billion may have purchased $8 billion in order to hedge their bets. Thus, some amount of this settlement will probably be having money simply going back and forth to the same firm. However, it is also widely believed that AIG was a major seller and thus on the hook for a huge amount. This, incidentally, is why the Fed chose to bail them out. Many hedge funds were probably net sellers. Thus, they are on the hook for large sums. One of the reasons why the market has been so volatile this past week is due to hedge fund liquidations in order to meet these calls due on Tuesday. Should any of the banks have huge exposure, this could lead to a major potential market selloff. On the other hand, if the settlement goes smoothly (i.e. everyone gets paid as expected) then the market might very well rally strongly. I will try to update this situation as we get closer.
Many people have asked me where to put their investment money now. If you wish personal advice, please call me at the number on the right side of this page. In the meantime, stay safe!
