C.M.O. 2.10.2009

Credit Market Overview

British Prime Minister Gordon Brown used it last week to describe the global economy but then it was called a slip of the tongue. Now IMF chief Dominique Strauss-Kahn is saying it about the world’s advanced economies: the U.S., Western Europe and Japan. What is it? The word depression.

Larry Summers disagreed on This Week with George Stephanopoulos saying “we were really in a very different situation then” the Great Depression.

The CIO of Bridgewater Associates, Ray Dalio, couches it slightly differently in Barron’s this week saying that what we’re going through is a “D-process” which to Ray is the combination of deflation and deleveraging and he says comparable periods are the Great Depression, the Latin American debt crisis and the Japanese experience.

Simon Johnson, former IMF Chief Economist and professor at MIT’s Sloan School of Management says the term refers to any significant contraction that lasts around 5 years.

What ever you do land up calling it Timothy Geithner is planning to announce measures today to fight its effects. These will include re-naming the TARP plan because it carries such negative connotations. Possibly of slightly more import are also plans to have the private sector become investors in the securities with the Treasury back-stopping losses over a certain threshold.

Industry people have a number of issues with the points that have been leaked so far including that it deals only with banks in the proper sense and with none of the institutions Bill Gross and others call the “shadow banking system”. Real banks it seems only account for 20% of the U.S. private credit market these days down from 40% in the 1970’s per Bianco Research in Chicago.

Vincent Reinhart of the American Enterprise Institute is a bit more acidic in his description saying, “What we need is a shock and awe campaign to fix the credit markets and what we’re getting instead is ‘aw shucks.’”

I have talked often in this space regarding the spreads on corporate debt at the moment and how, on a spread basis, they imply default rates exceeding those of the worst years of the Great Depression. Bill Gross echoes this sentiment and adds that the default rates could become self fulfilling prophesies if non-investment-grade corporations are forced to roll-over long term debt at levels of 20% or more.

There is a lot riding on Mr. Geithner’s plan. Let’s hope its more of Mr. Reinhart’s shock and awe and less of his aw shucks!

Enjoy the week.

Jim Delaney

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