Credit Markets Fear Meter Rising
Warren Buffett said we were on the "brink" last week.
That's pretty scary when you look at the unsettled nature of credit markets yesterday and again today, as Congress wrestles on hours of live television with the request to save Wall Street from itself.
But frankly, the scary thing is it's not just Wall Street being saved. It's all of us on Main Street being rescued from the ruins created by a loosely regulated, runaway finance system that allowed Main Street's businesses and homeowners alike to happily take on more debt than they could handle. That lending ultimately landed on the books of banks and brokers, as unwieldy, unmarketable piles of bad debt.
Perhaps Fed Chairman Ben Bernanke and Treasury Secretary Hank Paulson were just not clear enough in sending that message yesterday.
But today, Bernanke was pretty direct when he testified before the Joint Economic Committee. And it feels like the pendulum is about to swing the other way. It seems likely Congress will approve some form of plan but with plenty of strings attached.
Michael Darda, chief U.S. economist with MKM Partners, said he thinks Bernanke and Paulson have done just about as well as they could do under the conditions. But he said the markets reaction still shows they are not sure the problem will be fixed.
"I think that at this point the markets are just not convinced that what's being talked about is going to be effective or that political wrangling is going to let it get through...or both," he said.
Darda, in a note today, said credit markets took a turn for the worse with LIBOR/OIS rate widening this morning to a record 164.7 bps and the two year swap spread widening out to 143 bps, moving closer to levels it saw in the peak of panic last week. By mid-afternoon, the two-year swap was above 160 bps, a record level.
"The asset-backed commercial paper market has been turned upside down, suggesting the credit crunch is deepening," wrote Darda. Asset-backed commercial paper funds credit cards, auto loans, and short-term working capital for businesses. It's at the very heart of the financial system.
He noted that the asset-backed paper was under intense stress, with spreads on three-month paper vs Treasurys widening to 400 bps this morning after having narrowed temporarily from an all-time high above 500 bps last week.
The flight-to-quality trade into T-bills continued bills yielding micro levels. The stock market, meanwhile, drifts around on light volume. "We're much better to sell today," said one trader.
Darda says we'll face a bad economy no matter what the outcome. "We're at a point where the impact on the real economy could be very dire if something's not done so anyway you slice it the real economy is going to get worse before it gets better...I think people are nervous. The fact is there's already a recession that is in train here," he said in a phone interview.
Darda also pointed to the Fed's flow of funds report for the second quarter which showed household borrowing fell below net acquisition of financial assets for the second consecutive quarter after nine years of "deficits."
"It's good in the longer term but in the near term it means you have a consumer recession. The last time we had one of those was in the early 90s," he said.
"The best case scenario is we see recovery in the second half of next year and even with that it's going to be a mild one. It's going to take awhile to get out of these issues even if the bail out succeeds," he said.
What else did Buffett say? He said the bailout has to pass and succeed. That's why he made an investment in Goldman Sachs . (But, of course he structured his $5 billion investment in Goldman preferred to assure that his downside risk is limited)
"Last week we were at the brink of something that would have made anything that's happened in financial history look pale," Buffett said on "Squawk Box." "We were very, very close to a system that was totally dysfunctional and would have not only gummed up the financial markets, but gummed up the economy in a way that would take us years and years to repair. We've got enough problems to deal with anyway. I'm not saying the Paulson plan eliminates those problems. But it was absolutely, and is absolutely necessary, in my view, to really avoid going over the precipice."
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