Dissent on the Significance of the Bear Stearns Call

Bond Market Last Two WeeksI know that Cramer and many others consider the news from the Bear Stearns call to be the financial equivalent of nuclear meltdown, but it’s not true: Exhibit 1 is the graphic above from The Wall Street Journal (full story here). If you look closely at the graph, junk bonds had a small positive return last week. That would not be true in a crisis.

So what is the crisis? The crisis is in the exotic stuff.

  • Subprime ABS [asset-backed securities]
  • Credit default swaps and other derivatives on Subprime ABS
  • CDOs that contain Subprime ABS and certain high yield bonds and loans
  • LBO debt that some of the investment banks are stuck with.
  • Some high yield bonds and loans on deals that got done before the music stopped
  • Derivatives on broad classes of instruments like LCDX and CMBX.

But for the most part, for most high yield debt, almost all investment grade debt, and vanilla structured securities, the market is functioning. If anyone knows differently please contact me.Natively, I tend to be a skeptic and a bear. But I try to be a realist above all. I was managing a large portfolio of corporate bonds 2001-2003, and a large portfolio of CMBS (with a little ABS and RMBS) from 1998-2001. In 2002, the investment grade bond market shut down briefly on the mornings of two days, in July and October. (I remember my favorite broker saying to me each time, “The markets are offered without bid. What would you like to do? I had spare capital for the occasion and offered enough lowball bids to satisfy the extreme liquidity needs of the frightened.) At that time, the VIX and other systemic risk variables were thorough the roof. Those variables aren’t there now. After 9/11, the whole fixed income market was closed for five days, and even once it re-opened, it took two weeks to approach anything near normal. (People told me I was courageous/stupid to offer lowball bids on day two after the market reopened. They turned out to be good trades. I have stories from that period… as a bond manager, I am at my best in crisis mode.)

In 1998, when LTCM blew up, the bond market shut down. Only the highest quality stuff traded for about three weeks. I remember buying some AAA CMBS for almost 2% over Treasuries. We aren’t there at present; not even close.

Bear Stearns can make the statements that they did because they have a concentration in areas that are affected. They also want to make it look like as much of a market problem as possible, and not a Bear Stearns problem. For Bear Stearns, this very well could be the worst bond market for them in 22 years. Just not for the Street as a whole, at least not yet.

I write this not to make people bullish, but just to point out that characterizing the bond market as a whole is tough, and that things are rarely as bad as they seem. From my angle, I will say that I have seen it worse.
PS — A final note. After any crisis, how does the fixed income market comes back? It start with trading of bonds that are high quality, high simplicity, and short in duration. As the crisis abates, bond managers get tempted by the high yields of bonds that are lower in quality, lower in simplicity, and longer in duration. As the risk appetite expands, eventually the whole bond market comes back.