Five Signs That Subprime Infection Is Worsening(ZT)

Five Signs That Subprime Infection Is Worsening: Mark Gilbert
2007-07-29 19:05 (New York)


Commentary by Mark Gilbert
July 30 (Bloomberg) -- The collapse in subprime mortgages
doesn't pose ''any threat to the overall economy,'' U.S. Treasury
Secretary Henry Paulson said last week. He would, wouldn't he?
He's hardly going to advocate we all stock up on tinned food and
bottled water in our basements.
The tremors from the subprime debacle are vibrating
throughout the interconnected web of modern global financial
markets. Derivatives, corporate debt, loans and bank stocks are
all getting trashed. Here are five reasons to expect the turmoil
to worsen.

Don't Bet on Helicopter Ben . . .
A week ago, traders in the futures and options markets were
pricing the chances of December interest-rate cuts from the U.S.
Federal Reserve at about 21 percent. Prices now suggest a 47
percent chance that Fed Chairman Ben Bernanke will sanction lower
borrowing costs to rescue the mortgage market, based on July 26
closing levels.
The rapid turnaround in interest-rate expectations shows the
financial community is far from convinced that the wider economy
is immune from the woes afflicting particular pockets of the bond
and credit markets.
Is Helicopter Ben, as he was dubbed early in his monetary-
policy career, really going to fly over the global financial
markets and shower investors with dollar bills in the form of
cheaper money? Even a hint that the Fed might be planning a
rescue would be a signal that the outlook is bleaker than
officials have admitted so far.

. . . Do Bet Against Moody's
Investors made more than 23 million bets against Moody's
Corp.'s share price in the month to mid-July, according to
Bloomberg data on the total amount of stock that was sold short
and hasn't been repurchased yet. Those trades, known as short
interest, have surged from 18 million in mid-June, and have
almost quadrupled in the past four months.
Moody's shares have declined about 10 percent in the past
two weeks, extending their loss for the year to almost 20
percent. Frederick Searby and Jason Lowe, New York-based analysts
at JPMorgan Securities Inc., this month cut their second-quarter
revenue-growth forecasts for Moody's to 19.4 percent from 21.5
percent, and their earnings-per-share forecast to 68 cents from
69 cents.
''Should debt markets become less issuer friendly, CDO
issuance could be adversely impacted, hurting Moody's results,''
they wrote in a research report.

The Fundamentals of Leverage
The global default rate among corporate borrowers with
ratings below investment grade declined to 1.4 percent in the
second quarter from 1.5 percent in the first quarter, according
to Moody's. Just eight borrowers defaulted on $3.2 billion of
debt in the first half of the year. The default rate is now at
its lowest level in more than 12 years.
That hasn't prevented the iTraxx Crossover index, a
barometer of creditworthiness for 50 European companies, from
surging to as high as 440 basis points last week, up from about
260 basis points two weeks ago and a low for the year of 170 in
February. The higher the index, the less confident investors are
about the outlook for corporate bonds.
Once fear grips a leveraged market, the so-called credit
fundamentals aren't worth the paper you print your spreadsheets
on. The yield on the benchmark 10-year U.S. Treasury note has
declined to about 4.8 percent from as high as 5.3 percent seven
weeks ago, as investors seek the warm, comforting embrace of the
U.S. debt market.
''While the fundamentals, such as global growth and
corporate balance sheets, are at their best for arguably decades,
the technicals are as bad as we've ever known them and arguably
the worst in the era of leveraged finance,'' Jim Reid, a London-
based credit strategist at Deutsche Bank AG, said in a research
note last week. ''Never has so much money been thrown at and been
levered up in credit and never has there been such a liquid
derivatives market to hedge risk.''

It's Like Money in the Bank
After peaking at about 511 points on May 23, the Standard &
Poor's index of 92 U.S. financial stocks declined more than 10
percent through July 26, while the S&P 500 index fell just 2.6
percent. In the five years through the end of 2006, the financial
index posted a total return of more than 56 percent, outpacing
the 34 percent delivered by the benchmark index.
Here's a scorecard of some of the world's biggest banks,
from wherever the shares reached their high for this year
compared with closing prices on July 26. Bear Stearns Cos. is
down almost 28 percent. Royal Bank of Scotland Group Plc is down
21 percent. Deutsche Bank AG is down 18 percent. JPMorgan Chase &
Co. is down 17 percent. Goldman Sachs Group Inc. is down almost
17 percent. Citigroup Inc. is down almost 14 percent. So much for
the golden age of finance.

Not-So-Fizzy Drinks
Failing to finance deals that have already been agreed on is
one thing. Struggling to find a buyer for a business with some of
the world's best-known brand names is another. So last week's
news that Cadbury Schweppes Plc extended the deadline for selling
its U.S. drinks unit is a worrying sign that the cash to do a
deal might not be there at an acceptable price, no matter how
thirsty investors are for Dr Pepper and 7-Up sodas.
Every day brings a new failure. Borrowers ranging from
Manchester United Plc, the world's fourth-biggest soccer club by
revenue, to billionaire Barry Diller, chairman of Internet travel
agency Expedia Inc., have failed to find lenders to refinance
debt or fund share buybacks.
''The debate is whether this is simply a risk re-pricing in
financial markets, or something that will spill over into the
broader economy,'' says Charles Diebel, head of European rates
strategy at Nomura International Plc. ''The more prolonged this
credit event is, the more risks of a contagion.''