In the midst of a liquidity crunch

Another on the money article from MGETA.

Liquidity Crunch Looms

Click on the above link for the full article. Some interesting points of note were:

• Defaults on some so-called Alt A mortgages packaged into bonds last year are now outpacing those from subprime loans, according to Citigroup Inc. Bloomberg Article
  

• Between June 1 and July 17, typical spreads on BBB rated Alt A securities widened by 125 basis points to 475 basis points, while spreads for similar subprime securities rose 200 basis points to 450 basis points, according to Citigroup.

• Sales of CDO's plummeted to $9.1 billion in the U.S. this month from $42 billion in all of June, according JPMorgan Chase & Co. in New York.

The last part of Mish's article is worth repeating here for the "it's different this time" crowd.


The Ghost of Drexel Burnham Lambert

Kevin Depew on Minyanville gave everyone a history lesson in point one of Tuesday's Five Things.

1. Ghost in the Machine Slowly Grinding to a Halt

The market for collateralized debt obligations is slowly grinding to a halt, according to Bloomberg, threatening one of Wall Street's sacred cash cows - (read: $8.6 bln in annual underwriting fees) - and reducing the availability of credit for everyone from major Wall Street buyout firms to homeowners themselves.

• Sales of collateralized debt obligations (CDOs), which are used to pool bonds, loans and their derivatives into new debt, fell to $9.1 billion in July, down from $42 billion in June, analysts at JPMorgan Chase (JPM) said, according to Bloomberg.

What's behind the declining appetite for CDOs?

• The near collapse of two Bear Stearns (BSC) hedge funds, for one. The downgrade of 75 CDOs by the ratings agency S&P, for two. And concern about growing losses due to rising homeowner mortgage defaults, for three. Those are just for starters.

OK, so what are we really talking about here with these so-called CDOs?

• CDOs were created in 1987 by bankers at Drexel Burnham Lambert.

Wait a minute.
Did you say Drexel Burnham Lambert?
Isn't that the same firm that was driven into bankruptcy in 1990 due to illegal trading in junk bonds driven by Drexel employee Michael Milken?
And did you say they were created in 1987?
The same year the market crashed?
And wasn't the 1980s known as the "Decade of Greed"?

• Yes, yes, yes, yes and yes.

So let's see if we got this right. Today, in 2007, the market for securities that were created in the "Decade of Greed" by a firm that was only a short time later forced into bankruptcy due to illegal trading in high-risk bonds is grinding to a halt?

They say that history does not repeat but it does rhyme. In this case they have it wrong. CDO History is indeed repeating. What will also repeat is how the Fed will react to the problem. That way of course will be the same way the Fed reacts to every problem (by cutting rates). Regardless of whether or not that tactic works the next time (I doubt it), the attempt itself should be good for gold as the yield curve steepens.