P.S. Whomp I just picked up a copy of The Black Swan from my library. Will post my thoughts in your thread after reading it
Cool. I'd be interested to hear your thoughts. He spoke to a group of traders at the Chicago Mercantile Exchanage recently. Like everyone else who's in finance, economics, a Nobel Laureate or European they were not to happy with his presentation. He definitely knows how to get under people's skin. I think he makes some good points though. I think we're experiencing another what I'd deem to be a "black swan" event.
To give everyone a little background...there's a market where municipalities, student loan groups and closed end mutual funds went to borrow money short term (rate recalculated every 7 to 28 days) called the auction rate market.
It was a good deal for borrowers since they could issue cheaper debt than if they issued a 20 or 30 year bond. They're typically borrowing off a short term rate (say LIBOR). Buyers, like corporations (IE Microsoft has ~10% of their cash in these) and wealthy investors, liked them because they are very safe, were available every 7 to 28 days and had a bit of extra return over comparable short term maturities. This market worked flawlessly for 20 years and grew to $360 billion market....until last week.
A few auctions failed at Lehman Bros last week (meaning not enough buyers and Lehman did not want to not clear the rest of the bids by holding the paper on their balance sheet).
This little pebble has turned into a tidal wave. From Tuesday on virtually every auction failed across the country since on financial instituion wants another illiquid asset on the balance sheet.
For borrowers they had to pay a penalty rate to the investors (lenders). The highest quality borrowers paid an extra 0.2-0.3% however some borrowers like the Ports Authority of New York saw their cost of funds go from 4% to 20%. They ordinarily were paying around ~$60k a week for this debt and last week paid over $330k. This forces them to retire this issue and borrow at higher long term rates now. The problem for the buyer in many of these is don't have a market to sell the investment since there weren't any buyers. It's not a safety issue but a lack of a liquidity for them. They intended for these to be 7 to 28 day maturities. Now they are not.
You will hear more about this over the coming weeks and months. Some borrowers will have to retire their cheap money borrowings and float longer maturities. The highest quality borrowers (closed end mutual funds) won't need to do anyting since their cost only went up 0.2-0.3%. That means the investor will have to hold these securities without a chance to find a buyer for them. This will not be pretty folks.
There's other implications to the debt markets if the closed end mutual funds were to unwind this short term debt. With the short term money they are buying higher yielding long term tax free/taxable bonds, bank participations, preferred stocks etc etc etc. On a billion dollar fund they may have borrowed $250-333 million to buy more long term bonds. If for some reason the short term debt they're borrowing on gets unwound it will be really ugly for the long term debt their putting back to the market.
JH--heard much about this?
