IT´S 2007 AGAIN, THANKS TO THE U.S. FED / THE FINANCIAL TIMES

On Wall Street

November 30, 2012 1:50 pm

 

It’s 2007 again, thanks to the US Fed

 

By Henny Sender

 

 

 

 

Financial conditions are as loose today as they were in 2007, Ben Bernanke noted in a speech he gave in New York on November 20. The Federal Reserve chairman had good reason for that observation.




High-yield bond and loan market issuance year to date in both the US and Europe stands at about $570bn – on a par with the peak five years ago. Almost 30 per cent of all junk bonds have few terms, a new high, according to data from JPMorgan, while debt issuance for the purpose of paying the owners dividends is also above 2007 levels. Issuance of collateralised loan obligations this year will come in at about $45bn, more than the past four years combined.






Most shadow banks and credit hedge funds have never had it so good. So far, this year, distressed debt is among the best-performing hedge fund strategies. “You should be thankful for the Federal Reserve if you are an investor in credit markets,” notes Michael Cembalest, chief investment officer of the private bank at JPMorgan. “The rising tide in credit has lifted all boats.” Today, the debt of fewer and fewer companies trades significantly below 100 cents on the dollar, Mr Cembalest adds.







Also this past week, Equity Residential, the apartment landlord controlled by Sam Zell, partnered with AvalonBay to buy property company Archstone Enterprise, paying $6.5bn for 60 per cent and 40 per cent respectively. Archstone was formerly in the hands of Lehman Brothers. The bank’s original top-of-the-market purchase of Archstone was typical of the frenzied activity in evidence in 2007, as well as one of the main contributing factors to Lehman’s downfall.






Thanks to the Fed, there are so many ways in which it seems it is 2007 once again. But to what extent is that a good thing?






Mr Bernanke’s speech was hardly upbeat; it was all about the necessity for Washington to come to grips with issues surrounding the fiscal cliff, the package of tax increases and spending cuts due to take effect from January unless a deal is reached. But neither in the speech nor in the questioning after (led by his former colleague at Princeton University, Alan Blinder) was there much discussion about the downside of the current Fed policy.
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There are several downsides, quite apart from the fact that the Fed’s policies cannot continue indefinitely and their efficacy diminishes with each round of easing. That is one reason why Jeff Aronson, co-founder of Centerbridge Partners, returned money to investors recently. At this point, after so much credit spread tightening, there is far more potential downside than upside. Other drawbacks, of course, are that households cannot earn anything on their savings, pension funds are badly underfunded and insurers cannot generate enough investment income. The real beneficiaries of easy money are speculators.






Meanwhile, from a narrow financial markets point of view, yet another downside is the fact that market prices have lost any real meaning. Prices suggest that the world is a safer place but is it really?





Probably not. The world is much more frightening today than it was in 2008. Growth in most parts of the world is far slower, while Europe looks to be in recession.




Joblessness is a challenge in many parts of the globe. The geopolitical situation is far less stable. Governments are cash strapped and have far less room to support either their economies or their banks.
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Yet prices don’t reflect risk at all. Should Philippine government debt really be yielding 3.6 per cent? In 2008, it cost 800 basis points to buy protection against a Philippine default. In June, the price was 220bp. It is now a mere 100bp. Hedge funds nervous about the state of the world and seeking to buy protection in the credit default swap market have had a disastrous time as the credit markets keep tightening.
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In 2007, senior staff at the New York Fed compiled a list of all the indicators, suggesting the prices of many financial assets were no longer rational, and presented that list to their colleagues in Washington. Among the indicators they cited was a Middle Eastern telecoms group whose initial public offer was close to 700 times oversubscribed. Their concerns were dismissed.
This time, Mr Bernanke’s Fed is even more complicit.






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Copyright The Financial Times Limited 2012.