Friday, February 15, 2008

Credit market anecdotes and observations

With credit markets this week going into the third round of freeze up since August, there are plenty of observations from the securities dealers, bankers and asset managers about the problems that the market is facing. Here at in a 1/16/08 post, an opinion suggested that until large and liquid securitization markets were functioning again, most political and governmental efforts to improve the situation would be only marginally helpful at best and at times potentially harmful. That's all top down stuff. From the individual level, the so called man or woman on the street, here are two anecdotes.

------The $360 billion auction-rate securities market became dysfunctional this week. The financial press is all over it, and its a big and disturbing deal as another example of a previously investment grade liquid market in the process of closing down. In this example I'm the man on the street. I generally avoid writing about what I actually do as an investor but this example may just be too good to pass up, if somewhat tedious. Last week, on 2/6, I looked at the money market positions that I have as part of portfolios at two discount brokers. The money that I had allocated to money market funds in recent years has almost solely been focused on muni funds, as the tax advantage led to a higher effective yield than taxable money market funds. When I looked last week, however, I saw that the muni fund at one broker was yielding 1.7% while the taxable fund was yielding 3.9%. At the other the muni was 1.5% and the taxable was 3.7%. The tax benefit was no longer there. The effective yield of the taxable fund was over 60 basis point more than the muni. What happened.
My guess is that with the dislocation and the uncertainty in the muni market as a result of the troubles at MBIA, Ambac, FGIC and other insurers, the muni funds had become extremely conservative and moved their portfolios to the shortest maturities and the highest stand alone ratings possible. They could not take any risk of "breaking the buck". That had pushed down yields as demand for this quality of investment in the funds increased. The funds raised in the taxable corporate commercial paper markets did not have the same dynamic.
What did I do? With no transaction costs for moving between funds, the munis at both were moved to the taxable funds. It was the obvious rational move. While I am just a grain of sand on the beach of financial markets, it seems logical that the same action would have been taken by many institutional and individual markets participants. If this hypothesis is correct it would have led to signicant redemptions in the muni money fund market universe.
Get to the point. Muni money market funds are major buyers of the heretofore presumed 30 day paper produced by the auction rate securities market. As the demand declined the market became weaker, and funds that were experiencing redemptions could no longer risk buying 30 day paper that now had the risk of being turned into long term paper. This inclination escalated into a panic, and the auctions began to fail. One domino hits another.

------An acquaintance from the lunch counter at the local diner needed to buy a new car. His 12 year old minivan was both unreliable and costing more in unpredictable repairs than was justifiable. While my acquaintance would certainly characterize himself as middle class, my guess is that his income and asset level would have him barely hanging on to that category. He is a long time social worker with a steady job, likely with half decent benefits but a relatively low salary. He is divorced with three kids in their late teens to mid-twenties. I don't know his financial circumstances but he does seem to live paycheck to paycheck. Sounds tough, but he's a pretty happy guy.
He decides to get a new Hyundai Elantra, their least expensive model. He can put up only a very modest downpayment and his trade in is worth little. He agrees to buy the car and the dealership begins the search for financing. He sweats through a week long wait. They finally come through, and from what little he told me, and I don't pry, it seems that the rate was around 12% and that there was some sort of condition that prevented or penalized any type of refinancing for three years on a five or six year loan. He needed the car, he has a steady work history, a less than perfect credit rating it seems but no history of default on anything ever.
At street level, this is the consumer finance market without easily functioning securitization markets. He's looking forward to the Bush and Congress $600 but what does that solve really. He felt lucky to get any loan at all. He also now has a date with a receptionist at the car dealership. A couple of years ago, however, my guess is that he would have had the loan in a day at around 7% and with minimal conditions. That's a huge additional cost.

That's it from my desk and the diner.


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