CDS and Corporate Bond Markets face shrinkage

September 16, 2008

Update on September 18th: The outcome of this event has been even worse than I had anticipated. This post is updated here.  


The growth of the CDS market has been parabolic; a growth over 10000 percent over a period of about 10 years can easily be characterised as a bubble. In fact, the growth rate is greater than that of asset backed commercial paper, the implosion of which lies at the root of today’s problems. It remains to be seen if the CDS and bond markets will face the same consequences as asset-backed market, but there are signs that Lehman bankruptcy is providing a turnaround point to this relatively untried and unregulated field.


From Bloomberg: “Counterparties are being judicious in their actions at this point, given what’s happened,” said J.J. McKoan, who oversees about $65 billion as director of global credit at AllianceBernstein Holding LP in New York. “Few are willing to take on new risk positions.” In Bill Gross’ words dealers in the corporate bond and CDS market shave mostly been engaged in bookkeeping, as there’s little liquidity.


This lack of will to take new risk is reflected in widening spreads today. The number of corporate issues that are trading at distressed (high risk of default) levels is now close to 1100, and this is the highest level of the credit crisis. CDS indexes have also hit all time highs recently. While a brief rally in the stock market is possible in the coming days, provided that a solution to the AIG problem is found, and the Fed cuts rates, the CDS and bond markets are unlikely to participate strongly. Whether these markets will also contract or not is very important for the future of the economy.


Right now, contracts on Wachovia are trading at levels close to Morgan Stanley, and at 753 basis points, they are higher than the rates for Goldman Sachs, Citigroup, JPMorgan or Bank of America. CDS are strongly signalling, in this generally distressed environment, that Wachovia and Morgan Stanley present the greatest default risk.


Yesterday I posted about the need to follow the corporate bond market, and, here are the words of Mr. Henderson, the COO of GM, on the present state of the capital markets, via Reuters: 

“The bankruptcy filing of investment bank Lehman Brothers Holdings Inc. and the pressure on the financial sector will mean a short-term “contraction” in credit markets for corporate borrowers, General Motors COO Fritz Henderson said today.

Henderson, who was speaking to the Reuters Autos Summit in Detroit, said that the credit markets have been effectively closed to corporate borrowers except those with the highest credit ratings, but said the turmoil in the U.S. financial sector could add to the pressure.

“I would say things have been difficult already,” Henderson told Reuters. “Capital markets have been quite difficult, and this is just going to make it more so.”

He added: “We’re in for some rough waters here at least for this week if not the next couple of months.”

Henderson said GM, like other companies in restructuring, was already facing tough credit market conditions at a time when equity financing and private equity firms have also been in retreat.

“In terms of raising capital, you’ve got pretty much closed debt markets for anything other than triple-A-rated companies. You don’t have that avenue available to you,” Henderson said. “If you look at any company that’s got business challenges, the markets are very difficult to deal with.”


These remind of the sudden shutdown of the ABCP market last year.  The same phrases were used at that time “rough waters here at least for this week if not the next couple of months”, “closed to corporate borrowers” are the phrases we kept hearing for months, until writedowns began and financial firms resigned to the end of the securitization market.

Finally, today the Fed has left rates unchanged, but they will have to cut them soon, unless they bail out some large financial firms to calm the situation.




2 Responses to “CDS and Corporate Bond Markets face shrinkage”

  1. Brad said


    Great blog- I came across it about a week ago and have since bookmarked it. From what I gather, we share the same sentiments towards the US economy.

    If you haven’t already, I would recommend reading The Black Swan by Nassim Nicholas Taleb.

    Keep up the good work.

  2. moneymill said

    Thank you!

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