Tuesday, 16 September 2008

Risky times

Never seen this before in my life:

The graph above shows the overnight USD Libor rate. This is the annualised interest rate at which financial institutions lend funds to each other for a period of one day.
In one day, it trebled from about 2% to 6%.

It implies that the risk of default of A rated (or above) financial institutions that operate in this market has trebled overnight. Talk about efficient markets and rational investors.

Then, Morgan Stanley brings forward one day the announcement of quarterly results. And they look quite decent –if we trust the numbers, that is:

http://www.morganstanley.com/about/ir/shareholder/3q2008.html (PDF)

I know fully well the Firm is on the ball like no other outfit, but these results are surprisingly, suspiciously good. Share prices jumped about 20% in the after hours market, according to the FT. At exchange close however, they were down about 10%.

But the CDS 5Y tells a different story. After Lehman Brothers filed for bankruptcy, many financial CDS spreads have widened to below investment grade levels.
This is Morgan Stanley 5Y CDS curve:

Note: The graph is only upto yesterday's close. It does not include today's highs of 700bps.
It is a frighteningly similar curve to the one Lehman Brothers was exhibiting last week.

Tomorrow we will see what the market really thinks of Morgan Stanley's results.
Today the FED left the base rate at 2%.

In the UK, HBOS is on the receiving end of the market ire. Its 5Y CDS looks like that:

You will notice that the price of the CDS is lower than in many other financials.
HBOS recapitalised a few weeks ago to the tune of approximately £4bn.
The FT has a good article about it.
In my view, the loan/savings ratio is relatively high compared to peers at 177%. But is funding mix, is better than many others, with 55% of funding coming from retail deposits. The problem is going to be the refinancing of the debt maturing in the next few months. And that is the problem.
Given the recent market volatility, there is a real danger that insurance and fund management companies will pull out of the money markets altoghether. Money market is not only overnight or term deposits, Certificates of Deposit and Commercial Paper. It is also the crucial repo market, including the tri-party agreements now so common.
If money managers withdraw from the short-term money markets, firms like HBOS will find it impossible to refinance their short-term debt. It will be absolute pandemonium.
I hope that the ABI and the IMA, together with the Bank of England the the FSA and their international counterparts get together to draw a plan to prevent paralysis in the money markets. Otherwise, we are facing a financial crisis much, much bigger than The Great Depression.


Rab said...

Sometimes I don't know why I am bothered to write about financial markets when you can read the FT yourselves.

I think I will just link to the best articles. Like this beauty.

Rab said...

Or this other one by the superb John Kay. To his credit, he has been one of the few to have been issuing warnings about the current mess we are in.

John Kay

trevor said...

Dude, we're relying on you to cherrypick for us.