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Ahead of the pack
Aug. 21st, 2007 12:50 pmOh well, it's nice when what you spot as significant on Saturday, the Financial Times finally realizes is the front page story on Tuesday.
Part of the problem is that, whenever the BBC or a major newspaper deigns to put business on the front page, just about the most complex thing that it can cope with is the level of the FTSE 100.
So, here's Pete's easy guide for the non-financiers as to the important things which are happening at the moment.
1) Data from Dealogic showed that companies in Europe failed to refinance more than 80% of asset-backed commercial paper that matured yesterday. Yes, 80%. What does this mean? It means that there are a lot of chief financial officers out there who are tearing out their hair. Why? Because their "computer models" will have allowed for the cost of refinancing going up; perhaps those with a bit more foresight than the rest will have allowed for it going up significantly. But you can be sure that none of the models allowed for the market drying up completely.
What does this mean for companies? Well, KKR Financial said that it might have to raise $500m in an emergency rights issue. In other words, if the banks won't provide financing, we will go to the investors, in the hope that investors will be less scared than the banks. And what happens if the investors say no as well? Hmm, fucked if I know. But when we are talking about "emergency rights issues", institutional investors can smell blood. They will want a deep discount.
2) All that money which is not available to refinance corporate paper has gone into T-Bills (as mentioned here on Saturday). This was what caused the Fed to cut its discount rate on Friday. The panicked flight to safety in the short term (4-week bills) reached such a level that, following its fall in yield from 4.62% to 2.94% last week, at one point it fell another 175 basis points. At that point the arbitragers (the guys who used to work for LTCM in the mid 1990s?) must have spotted what looked mysteriously like free money. The 3-month bill was paying more than 2.5% (itself down 120 basis points from Friday) and the one-month bill was paying less than 1.5%. So, in they moved. The result was that the "flight to safety" knocked on to the 3-month bill (and also onto longer-term bills), down 66 basis points on the day to just over 3%, while the one-month bill fell a net 62 basis points to 2.33%. Some traders made one fuck of a lot of money yesterday. But those rates are unbelievably low compared to the minimum base rate (see below).
3) This is now way beyond the matter of subprime. One company that could not refinance yesterday was Ottimo Funding. It has no subprime mortgage liability; its credit rating is triple A. And guess what the banks said? Yep. "We don't give a fuck. Our money's in Treasuries".
4) Half of the $1.1tn in commercial paper comes due in the next three months. If there are no refinancers, that either means there is 500 billion dollars of emergency rights issues, or further forced selling of loan assets - not just subprime mortgages -- all loan assets. This could be a good time to buy fairly safe debt relatively cheaply.
5) The failure of the Fed's move on Friday to halt the flight to safety generated a few amusing comments. As per usual, John Authers had some interesting points to make. As he observed acerbicly
"The stockmarket has got the US Federal Reserve's message. The money market has not. Unfortunately, the message was intended for the money market".
So, while Radio Five's "Wake Up To Money" was talking of "calmer waters", it was talking about the stockmarket. Perhaps they should have been looking at what mattered -- the money markets, where the waters were anything but calm.
As Authers also observed:
In other words, this is uncharted territory. The free market is a wonderful thing ... when it works. As Lex of the FT observed, "the Fed does not necessarily have the weapons required to address the underlying problem".
And that's the nub of the matter. You can cut interest rates to 0%, but if risk aversion is so great that no-one is willing the lend anyone else any money, at any credit spread, then the Fed cannot invoke a law that makes the banks lend the money.
Well, that's the theory. In practice, I foresee some long meetings behind locked doors over the coming weekends, at which some bankers' arms will be seriously twisted.
So, let's assume liquidity returns (after some arm-twisting). Credit spreads (i.e., the gap in rates paid between "safe" and "risky" investments) will initially be artificially wide. The way to make money would be to bet on those spreads narrowing gradually over the coming 12 months. That would also mean a gradual shift out of T-Bills, resulting in the prices of those bills slipping back (i.e., the yields improving).
At the moment, there just HAS to be an arbitrage opportunity between the one-month, three-month and 12-month T-Bill rates. For once, it could be the hedge fund arbitrageurs -- those hated guys who used to be at LTCM, that actually provide some of the liquidity that gets the money markets out of noughth gear.
Part of the problem is that, whenever the BBC or a major newspaper deigns to put business on the front page, just about the most complex thing that it can cope with is the level of the FTSE 100.
So, here's Pete's easy guide for the non-financiers as to the important things which are happening at the moment.
1) Data from Dealogic showed that companies in Europe failed to refinance more than 80% of asset-backed commercial paper that matured yesterday. Yes, 80%. What does this mean? It means that there are a lot of chief financial officers out there who are tearing out their hair. Why? Because their "computer models" will have allowed for the cost of refinancing going up; perhaps those with a bit more foresight than the rest will have allowed for it going up significantly. But you can be sure that none of the models allowed for the market drying up completely.
What does this mean for companies? Well, KKR Financial said that it might have to raise $500m in an emergency rights issue. In other words, if the banks won't provide financing, we will go to the investors, in the hope that investors will be less scared than the banks. And what happens if the investors say no as well? Hmm, fucked if I know. But when we are talking about "emergency rights issues", institutional investors can smell blood. They will want a deep discount.
2) All that money which is not available to refinance corporate paper has gone into T-Bills (as mentioned here on Saturday). This was what caused the Fed to cut its discount rate on Friday. The panicked flight to safety in the short term (4-week bills) reached such a level that, following its fall in yield from 4.62% to 2.94% last week, at one point it fell another 175 basis points. At that point the arbitragers (the guys who used to work for LTCM in the mid 1990s?) must have spotted what looked mysteriously like free money. The 3-month bill was paying more than 2.5% (itself down 120 basis points from Friday) and the one-month bill was paying less than 1.5%. So, in they moved. The result was that the "flight to safety" knocked on to the 3-month bill (and also onto longer-term bills), down 66 basis points on the day to just over 3%, while the one-month bill fell a net 62 basis points to 2.33%. Some traders made one fuck of a lot of money yesterday. But those rates are unbelievably low compared to the minimum base rate (see below).
3) This is now way beyond the matter of subprime. One company that could not refinance yesterday was Ottimo Funding. It has no subprime mortgage liability; its credit rating is triple A. And guess what the banks said? Yep. "We don't give a fuck. Our money's in Treasuries".
4) Half of the $1.1tn in commercial paper comes due in the next three months. If there are no refinancers, that either means there is 500 billion dollars of emergency rights issues, or further forced selling of loan assets - not just subprime mortgages -- all loan assets. This could be a good time to buy fairly safe debt relatively cheaply.
5) The failure of the Fed's move on Friday to halt the flight to safety generated a few amusing comments. As per usual, John Authers had some interesting points to make. As he observed acerbicly
"The stockmarket has got the US Federal Reserve's message. The money market has not. Unfortunately, the message was intended for the money market".
So, while Radio Five's "Wake Up To Money" was talking of "calmer waters", it was talking about the stockmarket. Perhaps they should have been looking at what mattered -- the money markets, where the waters were anything but calm.
As Authers also observed:
But the three-month Treasury-bill yield fell on Friday, showing a continued flight to quality. On Monday morning, the T-bill yield fell more than 120bp, to 2.53 per cent. Usually it stays close to the Fed Funds rate, which stayed at 5.25 per cent.
This is the sharpest move in T-bills in decades, dwarfing anything from the tech bubble, or even the Black Monday crash of October 1987.
In other words, this is uncharted territory. The free market is a wonderful thing ... when it works. As Lex of the FT observed, "the Fed does not necessarily have the weapons required to address the underlying problem".
And that's the nub of the matter. You can cut interest rates to 0%, but if risk aversion is so great that no-one is willing the lend anyone else any money, at any credit spread, then the Fed cannot invoke a law that makes the banks lend the money.
Well, that's the theory. In practice, I foresee some long meetings behind locked doors over the coming weekends, at which some bankers' arms will be seriously twisted.
So, let's assume liquidity returns (after some arm-twisting). Credit spreads (i.e., the gap in rates paid between "safe" and "risky" investments) will initially be artificially wide. The way to make money would be to bet on those spreads narrowing gradually over the coming 12 months. That would also mean a gradual shift out of T-Bills, resulting in the prices of those bills slipping back (i.e., the yields improving).
At the moment, there just HAS to be an arbitrage opportunity between the one-month, three-month and 12-month T-Bill rates. For once, it could be the hedge fund arbitrageurs -- those hated guys who used to be at LTCM, that actually provide some of the liquidity that gets the money markets out of noughth gear.
