C.M.O. 2.17.2009

Credit Market Overview
February 17 2009

In life, business and of course trading it is always good to learn form your mistakes. It appears Moody’s has taken this to heart as after having rated a whole bunch of mortgage backed paper AAA that probably didn’t deserve a single “Z” (not that there is such a rating) they have now examined the sovereign debt market and come up with three sub-categories for those countries whose debt they put on their top-shelf.

The categories are “resistant”, for those nations that are unlikely to be downgraded by the current global crisis; countries that fall into this category include Germany, Canada and (can you believe it) France. Their next category is “resilient”, for those nations that are being affected by the credit crisis but should be able to adjust and get themselves back to “resilient” status. The U.K. and ourselves fall into this category. Then there are those nations Moody’s deems “vulnerable”, with Ireland and Spain being the best examples.

The criteria Moody’s uses to decide which bucket a country belongs, or more importantly, what the cause of a downgrade could be are the material deterioration in the affordability of the debt, a deterioration in affordability relative to other sovereigns and the inability to correct the problem.

So after hearing about this I looked up the CDS spreads for the countries in question to see what the market thought. Germany trades at the lowest number of basis points, 70 with France in 2nd place at 74.5. I couldn’t find Canada’s CDS spread on Bloomberg but it might be tough to default on snow. In the next category the U.S. and U.K are trading at 87bps and 151.6 respectively while Spain is trading at 160 and Ireland at 376.63

87bps doesn’t seem that far away from 74.5bps which is France’s 5-yr CDS level but it does seem pretty far away the U.K.’s 151.6 so it’s not clear that the market agrees with Moody’s but it will be interesting to see how things change as the ever increasing deficit is financed through ever increasing quarterly refundings of U.S. Treasuries.

Already cognizant that the deficit is on its way to “way too big” Barack Obama has scheduled a “fiscal-responsibility summit” for February 23rd. On Friday the President told business leaders at the White House: “We are not going to be able to perpetually finance the levels of debt the federal government is currently carrying.”

This seems to be a realistic assessment but the risks taken by passing a massive spending bill can only be increased if an attempt is made to recover the spent monies too quickly. Christina Romer, chairman of he White House Council of Economic Advisors sites the “seesaw” nature of spending in FDR’s New Deal when Mr. Roosevelt would spend big one year and then back away the next, never allowing the economy to really get traction.

If this was never done before all arguments would be equal because the outcome would yet to be unknown. Given the mistakes made with the New Deal it doesn’t look like the government has learned from its mistakes. Hopefully Moody’s has.

Enjoy the week.

Jim Delaney

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