The Hindu Business Line : Does debt paper look cheap for govts, central banks?

World over, the prices of non-government paper have fallen sharply, (i.e., their yields have risen). ‘AAA’ securities are no exception. They too have been trashed. Such is the level of risk aversion now in financial markets and is, of course, typical of their lemming-like behaviour.

In the context of equities, that doyen of investment, Benjamin Graham, described a mythical Mr Market, who offers daily buy and sell prices for stocks. The thing about Mr Market, according to Mr Graham, is that he is prone to wild mood fluctuations. On some days and in some times, he quotes sky high prices, matched by absurdly low prices on other occasions. Mr Graham’s advice was simple: ignore Mr Market’s swings and invest based on the long-term value of a company’s business.

Credit default swaps

Bond and credit markets, in general, were not prone to the same degree of volatility as stocks, being in the nature of fixed claims and backed by ratings. But all that seems to have changed. Blame it on the new-fangled derivative called credit default swaps (CDSs). These continuously and in real time show the cost of default protection of traded debt securities. Trading volumes in CDSs are in hundreds of billions of dollars and outstanding swaps in the trillion-dollar region.

With the arrival of the mortgage and sub-prime crisis, the prices of CDSs have soared as the market factors in increasing probabilities of defaults. In turn, these (naturally) impinge on the prices of the underlying securities and credits, which are financed with borrowed money and leverage. When prices fall, margin calls from lenders follow, but there is not enough equity to meet lenders’ demands. The result is a downward spiral of prices from forced selling and an upward spiral of bankruptcies if the assets cannot be sold.

Spreads at a record

Thus, yields on investment grade mortgage and mortgage-backed securities (as well as other debt paper such as municipal bonds) have reached never before seen spreads over Treasuries. Similarly, the prices of credit default swaps are several hundred basis points for high-quality credits. Implicit, in many cases, are extraordinarily high default rates, out of line with all past experience.

Central banks may have decided it is enough. The talk over the weekend is of their (or their governments) stepping in to buy mortgage debt off banks and their special investment vehicles.

It might sound like a bailout but might also make eminent investment sense – as Warren Buffett says, buy when everyone is fearful. Governments and central banks could well end up making a neat pile of money, leaving the market to rue its foolishness in having sold right at the bottom.

More Stories on : Financial Markets | Corporate Bonds | Financial Scan

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Corp Bank to pay 45% interim

Re rises further tracking equities

Does debt paper look cheap for govts, central banks?

PSU banks may scale up hiring by 30% next fiscal

Unions take it with a pinch of salt

RBI’s largesse

Federal Bank to open 26 branches today

Syndicate Bank to speed up loans to farmers in Karnataka

Bond prices fall

Union Bank sees lower credit growth this fiscal

RBI issues revised draft guidelines for recovery agents

Call rates changed

SBI gets full bank status in Singapore

Khandelwal to head AMC venture