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As market psychological goes, isn’t it normal for a market filled with excess to take time to transition from greed to fear? The intiial decline in the NDX in March/ April 2000 was very sharp, but was bought aggressively. The eventual rolling over didn’t occur until September 2000. From a psychology standpoint, would you characterize the current CDO market in a similar vein? As the old saying goes, peaks tend to be a process rather than a point!
David; do you have an opinion on “Stigum’s Money Markets” that Tony C. worked on for the 4th revision? I’ll read it if you believe it is useful.
I have not read it. If you want to learn a lot about one-year and shorter fixed income securities, it looks like a good book. Hard to add a lot of value there though.
James, I’m still worried, but the troubles seem less immediate. The three great distorting factors in the securities markets are the CDO bid, the VC/buyback bid, and the continuing need to recycle dollar claims created by the trade deficit.
This whole party has gone on a lot longer than I would have expected; it will end badly, as they all do. I will rely on my normal risk control measures to work as the trouble hits, but I don’t move to cash as a risk reducer… if one leaves the game it is hard to get back in.
Have you done (or do you know of) any quantitative work done on your view that CDO or other debt funding is predictive? The logic is compelling. TonyC argues similarly for corp. bond funding, commercial paper, bank lending etc.
In doing some rudementary research on it though, it looks to me that the causality may run the other way. In other words, funding is getting done on the basis of expectations of the continuation of recent expansionary conditions.
For example, in reviewing a chart of GDP growth vs. business lending since 1947, business lending appears to lag somewhat, not lead.
Thank you David
Estragon, I’m open to other interpretations. Given that lenders tend to be trend followers rather than leaders, you may have a point. Marginal lenders make loans at the top that in hindsight were bad moves.
I’ve been a mortgage and corporate bond manager in my time, so let me give you a little more of my perspective. In the late 90s, there was a great flowering of cash flow CDOs that we have not seen in this decade. The CDO sponsors were too piggish, and optimized the CDO structures (which invested in junk bonds) for the short-term benefit of the equity holders. For a while it was a virtuous cycle, until junk bond defaults ticked up, and later raged. The greed of the equity and subordinate buyers allowed junk bonds to come to market that never should have seen the light of day, but were able to be issued because of the CDO bid. Only when the defaults hit did the CDO bid dry up. Today, the only assets that use a structure like that are pooled bank trup deeals, and other “one off” type transactions.
In the Manufactured Housing ABS market, before things went south, lenders were doing all sorts of workouts with borrowers just to keep them “current.” This benefited the equity of the deal at the expense of the senior holders, who would have wanted foreclosure. At the end, loan quality was abysmal, before the market shut down (minus one firm) altogether. No one would buy the subordinate paper any more, and the originators didn’t have the cash to take down the equity of the deals.
Moral: Bubbles pop when cash flow is insufficient to finance them.
I appreciate your perspective. Thanks