Tuesday, March 10, 2009

Causes of Credit Sector "Strains"

Media reports of the past several days have been replete with accounts of the "renewed concerns" within the credit markets, evidenced by widening yield spreads on even the highest rated investment grade debt. It appears that the brunt of the stress is concentrated within the financial sector, specifically in relation to the four "mega-banks". Now, given that the layer of the capital structure known as common equity does not actually even exist for these four banks,  the decision regarding outright purchase of their stock is an easy one. Debt however, has until recently been a different story.

Returning to a theme commonly cited on these pages, these recent levels of credit market distress are simply a reflection of a lack of investor confidence, based mostly upon erratic Government behavior. The Purchaser of debt issued by the four major banks is basically purchasing the hope that the Government does not wipe him/her out via concoction of a haphazard rescue scheme. Ironically, in the Government's frantic effort to rescue one industry, they have further endangered another, the Insurance industry. As major players in the Credit Markets, the Insurance Companies stand to be dealt enormous investment portfolio losses based upon bond holdings now trading at distressed levels. This is not surprising however, as the Government has proved thus far that it does not possesses the ability to read even a half-move ahead in any situation.

The sad thing is, credit market disruptions in September were a result of fear of institutional failure, while today, the Government has become the Ogre that the village fears.
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