Everyone needs a helping hand at some point in life. Such was the case with me when, at four or five years old, I managed to topple a freestanding, double-sided chalkboard on myself while playing in an empty classroom at my local school. I do not know how long I lay under the chalkboard before my excellent aunt lifted that weight off of me, but I recall having just enough lung capacity and strength to belt out the loud, long screams it took to summon her to my aid.
Readers know where this is headed. The Federal Reserve's decision to roll back its federal funds target rate by 50 basis points on Sept. 18 was very similar to that chalkboard episode. It was a helping hand extended to a small segment of the financial markets that took on more risk than it understood or could effectively manage. What a shame, because the capital markets passed by another major opportunity to correct itself. Instead, the sector probably shored up its public image as a mysterious and unsafe segment of the financial markets.
Understandably, the situation facing the credit markets was serious. Access to short-term money markets was cut back significantly. In one example, the amount of ABCP outstanding in the U.S. declined from $1.8 trillion to $929 billion, a 21% drop between Aug. 8 and Sept. 19, according to UBS.
"I think it was necessary. I think it was helpful," said John Rosenthal, a partner with Nixon Peabody. "If they had not acted, particularly after the jobs report number that came out immediately before, it would have been interpreted as: Fed to market: Drop dead.'"
The structured finance market in particular endured more credit rating downgrades and subsequent price volatility than it anticipated, so it needed an extra boost of liquidity to get pricing back in line with market norms, said Brian Yelvington, an analyst at New York-based research firm CreditSights. Collateral-level data in ABS and MBS deals are not as detailed as information made available to CLO investors.
"Contrast that with an ABS credit-card deal. I have no idea about the [quality of the] underlying assets ... other than a FICO score, the average loan size and prepayment speeds," Yelvington said. "There was a lot of dependency on the rating agencies in both areas."
Maybe so, but remember that most vaporized ABCP debt quickly became bank debt, as liquidity providers were forced to step in and bring the assets onto their balance sheets, say market observers. During the liquidity lockup, spreads on ABCP widened to Libor plus 45 basis points, according to some market estimates. This is the redistribution of debt and repricing of spreads, not an insurmountable barrier between issuers and the credit markets.
By insisting that the Federal Reserve get involved, the markets might have lost an opportunity to determine the course of the inevitable recovery ahead, as last week's Senate hearings on the role of credit rating agencies in the subprime credit markets implies.
The capital markets deserve credit for coming up with innovative structures. While those structures tended to stellify the CDO and RMBS markets, however, there was a growing distance between the spreads on those securities and the underlying credits. Perhaps when institutional investors begin to restore liquidity to the ABS and MBS markets, they should insist on disclosures that would ultimately allow them to determine spreads more accurately, keep the markets stable and leave the Fed to tend to weightier matters.
(c) 2007 Asset Securitization Report and SourceMedia, Inc. All Rights Reserved.