Monday, October 15, 2007

Credit Market with the Jitters

The corporate credit market still appears to have a bad case of the shakes, to the point that investment banks coordinated by the Fed are preparing for a bail-out.

The sales of commercial corporate paper have suffered over the past few weeks due to the fear wrought by the subprime sector. Despite the contagion, commercial paper sales have increased during the past few weeks giving some the perspective that the possible crisis is in the rear view mirror.

However the rather large Structured Investment Vehicle (SIV) market, that is generally associated with lower quality corporate debt, appears to have come to a complete halt. These derivatives are backed by commercial paper, and are similar to the CDOs that have provided excessive angst in the subprime market. Generally the SIVs used short-term commercial paper with low interest rates to purchase longer-term mortgage-backed securities and other instruments with higher rates of return. A market arbitrage that bears resemblance to international interest-rate carry trades, but tends to blow up spectacularly when one of the underlying tenets alters

The banks would create a Super-SIV fund (Master Liquidity Enhancement Conduit or M-LEC) that would provide emergency financing to bail out SIV entities in order to prevent sell-offs. The Fed and Treasury hope that this will reassure investors in these vehicles and kick some life back into the commercial paper market.

The key question remains regarding how much impact this event should bear over the broader stock market. Deteriorating credit conditions are normally very bad news for investors. Should the implementation of this SIV fund from the banks be taken as fair weather news to calm the seas or with a dose of fear?

Banks May Pool Billions to Avert Securities Sell-Off

Banks set plan to revive credit market