Most Popular
1. THE INFLATION MONSTER is Forecasting RECESSION - Nadeem_Walayat
2.Why APPLE Could CRASH the Stock Market! - Nadeem_Walayat
3.The Stocks Stealth BEAR Market - Nadeem_Walayat
4.Inflation, Commodities and Interest Rates : Paradigm Shifts in Macrotrends - Rambus_Chartology
5.Stock Market in the Eye of the Storm, Visualising AI Tech Stocks Buying Levels - Nadeem_Walayat
6.AI Tech Stocks Earnings BloodBath Buying Opportunity - Nadeem_Walayat
7.PPT HALTS STOCK MARKET CRASH ahead of Fed May Interest Rate Hike Meeting - Nadeem_Walayat
8.50 Small Cap Growth Stocks Analysis to CAPITALISE on the Stock Market Inflation -Nadeem_Walayat
10.Apple and Microsoft Nuts Are About to CRACK and Send Stock Market Sharply Lower - Nadeem_Walayat
Last 7 days
Elliott Waves: Your "Rhyme & Reason" to Mainstream Stock Market Opinions - 6th Aug 22
COST OF LIVING CRISIS NIGHTMARE - Expect High INFLATION for whole of this DECADE! - 6th Aug 22
Recession Is Good for Gold, but a Crisis Would Be Even Better - 5th Aug 22
Stock Market Rallying On Slowly Thinning Air - 5th Aug 22
Stock Market Trend Pattren 2022 Forecast Current State - 4th Aug 22
Should We Be Prepared For An Aggressive U.S. Fed In The Future? - 4th Aug 22
Will the S&P 500 Stock Market Index Go the Way of Meme Stocks? - 4th Aug 22
Stock Market Another Upswing Attempt - 4th Aug 22
What is our Real Economic and Financial Prognosis? - 4th Aug 22
The REAL Stocks Bear Market of 2022 - 3rd Aug 22
The ‘Wishful Thinking’ Fed Is Anything But ‘Neutral’ - 3rd Aug 22
Don’t Be Misled by Gold’s Recent Upswing - 3rd Aug 22
Aluminum, Copper, Zinc: The 3 Horsemen of the Upcoming "Econocalypse" - 31st July 22
Gold Stocks’ Rally Autumn 2022 - 31st July 22
US Fed Is Battling Excess Global Capital – Which Is Creating Inflation - 31st July 22
What it's like at a Stocks Bear Market Bottom - 29th July 22
How to lock in a Guaranteed 9.6% return from Uncle Sam With I Bonds - 29th July 22
All You Need to Know About the Increase in Building Insurance Premiums for Flats - 29th July 22
The Challenges on the Horizon for UK Landlords - 29th July 22
The Psychology of Investing in a Stocks Bear Market - 26th July 22
Claiming and Calculating The Research and Development Tax Credit - 26th July 22
Stock Market Bearish Test - 26th July 22
Social Media Tips and Writing an Effective Call to Action - 26th July 22
Has Rishi Sunak Succeeded in Buying His Way Into No 10 - Fake Tory Leadership Contest - 26th July 22
The Psychology of Investing in a Stocks Bear Market - 26th July 22
Claiming and Calculating The Research and Development Tax Credit - 26th July 22
Stock Market Bearish Test - 26th July 22
Social Media Tips and Writing an Effective Call to Action - 26th July 22
Has Rishi Sunak Succeeded in Buying His Way Into No 10 - Fake Tory Leadership Contest - 26th July 22

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

Credit Crunches Typically Have Proven to be Investment Opportunities

Stock-Markets / Credit Crisis 2008 Feb 22, 2008 - 03:29 PM GMT

By: Steve_Selengut

Best Financial Markets Analysis ArticleMany investors are beginning to think that income investing is every bit as risky as equity investing, but nothing has really changed in the relationship between these two basic building blocks of corporate finance. What has changed in recent years is the nature of the derivative products created by the wizards of Wall Street to deliver both forms of securities to investors. The most popular form of equity delivery today is the three-levels-of-speculation Index Fund. New ETFs are birthed every day and, in total, have become as common as common stocks. Have you noticed that regulators always strive to prevent financial disasters from happening... again?

But, in the meantime, the forever-sacred bond market has become the hysteria arena of the moment in media, country clubs, neighborhood pubs, and retirement villages. Does my nest egg have a crack in it? No, not really.

Stories abound concerning the sub-prime mortgages that financed the recent bubble in real estate prices. Many people, who couldn't afford to purchase homes at any price, were able to obtain financing with no-documentation-required mortgages. Many loans had sub-prime, short-term teaser rates that would adjust to above market levels too quickly. Many borrowers weren't concerned because they never intended to occupy the properties… speculators attempting to flip the properties quickly in a much too hot real estate market. Predatory lenders and some greedy realtors exacerbated the problem. Lenders didn't care because the bad loans and higher risks were gobbled up by Wall Street institutions to be sliced, diced, seasoned, and syndicated into CMOs, CDOs, and SIVs of all imaginable shapes and risk levels.

Rating agencies gave the products AAA status because they were guaranteed. Insurers guaranteed the derivatives because they were AAA rated. Investment bankers underwrote and syndicated the products because of their high quality ratings and their banker friends made markets for them through their trading desks. It was party time on Wall Street, as it always is before such MLMesque schemes unravel. Have you noticed that regulators always strive to prevent financial disasters from happening... again? You can bet that attorneys have.

So when over-the-top real estate prices began to settle and the flippers were hooked with homes that began to smell fishy, the houses-of-cards began to tumble, bursting bubbles and drowning speculators as they fell.  Borrowers with adjustable rate mortgages had to face new financial realities, but contrary to the picture painted by the media, most homeowners are making their payments right on schedule. Speculators should expect losses, but should financial institutions encourage the speculators? Welcome to Las Vegas east.

It is practically impossible to determine how many and precisely which mortgages within the CDOs and SIVs are in or near default. As a result, the market value of these products has fallen to levels that unrealistically presume a major default experience. The fact that Wall Street leveraged some of the products excessively has made a bad situation worse, and banks worldwide have written down billions on mortgage portfolios that contain an unknown number of potential defaults. But regardless of the financial reality, the market value reality of having no buyers for these securities has caused a global panic and spiraling illiquidity in the financial markets. So, as a result of their self-inflicted capital-raising problems, the banks have become risk averse with everyone. Aren't banking and mortgage lending regulated industries? Is it time to change the way banking institutions assess the value of their debt investments?

Individual investors have always relied upon fixed income obligations to fund everything from college to retirement. Historically, the default rate on corporate bonds has been low, and that on Municipal bonds approaches zero. Dot-com debt was added to the markets in the later half of the 1990s, and the 8% leveraged-corporate-bond default rate in that era helped cause recession a few years later. But corporate balance sheets were far less liquid than they are today, and by early 2004 the default rate was under 1%. In late 2005 there was a short-term spike to 2%, but since then the default rate has dropped to a recent historic low of 1/4 of 1%.

There does not seem to be a major quality issue within corporate debt right now, but fearful investors have abandoned all but treasury securities... finding even the commodity markets more of a safe haven than Municipals. Boy, are they in for a surprise. The fear of a routine cyclical economic slowdown and the credit crunch has caused massive selling of income securities while the default rate has not increased at all.

Corporate and municipal closed end funds have not responded normally to recent reductions in interest rates because of the general problems plaguing the industry and, additionally, because of questions about the Auction Rate Preferred Stock (APS) they use to finance short-term borrowing. (Keep in mind that nearly all corporations and municipalities use debt financing and that such financing is not, in and of itself, a bad thing.) APS in effect resets the interest rate the borrower pays every seven to twenty-eight days. The preferreds are mostly purchased by banks, but may also be sold to individual investors. The credit crunch that originated with the sub-prime problem has spread to the APS market as well. Consequently, CEF managements now have a higher cost-of-carry on short-term borrowing.

APS issues include maximum interest rates that are generally well below the amounts the funds receive from their holdings, and all Closed End Funds can raise new capital by selling additional shares of stock. As long as the earnings generated by the assets in the portfolio continue to exceed the costs of the APS financing, such financing is beneficial to the shareholders. Should the cost approach the revenue, the manager can simply redeem the APS and reduce the holdings in the portfolio.

To alleviate the problems, central banks worldwide have injected billions to help ease tight credit conditions. Ours has slashed the Fed Funds rate to lower borrowing costs and to ease general credit conditions; more rate cuts are expected. Unlike the quality issues in the sub-prime mortgage market, the weakness in the corporate and municipal CEF markets is a more solvable liquidity problem. Historically, the easing of interest rates and injection of reserves into the system eventually move credit markets toward normal conditions. The Fed Funds rate now stands at 3%, down from 5.25% a few months ago. In 2003, the rate moved to 1% as the Fed liquefied the credit markets after 911; there is still a lot of rate cutting room in the system.

Investors would fare better if they could learn to think long-term in the face of short-term problems. This is not the first, and certainly not the last, dislocation in the financial markets. The Treasury Secretary and the Federal Reserve Chairman have testified that they expect economic growth to resume during the second half of 2008. The congressional stimulus package will be implemented quickly. The Fed stands ready with rate cuts and will inject additional reserves if needed. Typically, credit crunches with or without stock market corrections have proven to be investment opportunities. This one will be no different.

By Steve Selengut
Professional Portfolio Management since 1979
Author of: "The Brainwashing of the American Investor: The Book that Wall Street Does Not Want YOU to Read", and "A Millionaire's Secret Investment Strategy"

Disclaimer : Anything presented here is simply the opinion of Steve Selengut and should not be construed as anything else. One of the fascinating things about investing is that there are so many differing approaches, theories, and strategies. We encourage you to do your homework.

Steve Selengut Archive

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


23 Mar 08, 23:05
thanks much

i am gonna show this to my friend, dude

Post Comment

Only logged in users are allowed to post comments. Register/ Log in