The Credit Crisis: Are We Approaching a Depression?
Dec 3, 2008
Posted by Jody Eisenman | Filed under crisis
Several items on the credit markets continue to dominate economic news. Simply put, these markets continue to remain virtually closed to any bond offering that is not either a US treasury, or an FDIC insured instrument. As such, we are seeing unprecedented spreads between US treasury yields and everything else. For example, today the Port Authority of New York and New Jersey announced that they had received zero bids for a 3 year $300 million taxable bond offering. These notes have the highest short term ratings issued by Moody’s and S & P. Its’ four previous offerings received an average of nine bids. What this means is that potential underwriters (generally large banks like Citi and JP Morgan) do not feel that they can resell them to potential investors.
According to an article in Bloomberg.com, the demand for top rated commercial real estate bonds has also completely collapsed. According to Barclay’s analysts, the spread of these bonds relative to benchmarks is now 11.9%. In January, it was 0.82%. These numbers are reflected in demand. A record $237 billion bonds were sold in 2007. The number for 2008 year to date is $12.2 billion.
Finally, according to John Lonski, the chief investment strategist at Moody’s, current yields on junk bonds imply a default rate of 21%. To put this in perspective, the default rate was 15.4% in 1933 during the depression.
The spread between high yield bonds and treasuries is now astronomical. This spread was around 220 basis points a year ago. It is now close to 2000. What this means is that investors are unwilling to buy any bonds they perceive as risky. Unfortunately, investors are now defining “risk” as anything that’s not US government guaranteed. Under this scenario, companies cannot borrow or refinance their existing debt. Unless this changes, I believe that we are going to be facing bankruptcies of unprecedented levels. In this type of scenario, I further believe that any talk of a bottom in the equity markets is simply way too premature.
