February 14, 2008

1) A new credit crisis has exploded on to the scene. The Auction Rate Securities Market has failed. This is a $300 billion market for floating rate notes for municipalities. It is the primary vehicle for public authorities to raise cash to pay short term bills. For example, Port Authority of New York and New Jersey bonds, which normally yield 4%, are now yielding 20%. Usually dealers step in to soak up any warehouse excess paper in the market, but they can't now because they are all capital constrained and in risk reducing mode. If this problem is not sorted out soon cities will have to start laying off employees and suspending services for lack of funds. This is a totally unnecessary crisis because no municipality has defaulted since Orange County did so in 1994. At the very least this will increase borrow costs for public entities.

2) On the good news front, Morgan Stanley and Bear Stearns managed to place $1.2 billion in mortgage backed securities last night, the first such placement this year. They are yielding 235 basis points over treasuries vs. 60 basis points a year ago. It's just a toe in the water. Granted, this was for a package of commercial real estate loans and not residential loans, and the size is very small, but it is an important step in the risk repricing and market reopening process. Now others have a price they can trade around. History shows that these initial deals after any crisis always turn out to be immensely profitable. Please recall people buying S & L loans in the early nineties for 10 cents on the dollar. The same happened in Japan. This has a 'light at the end of the tunnel' feel to it.

3) The Swiss bank UBS announced a quarterly loss of $11.3 billion, the largest in history.  It has remaining exposure in sub prime of $28 billion. I was a director of this company for a year and have to say that I am not surprised. They were always the most aggressive of the Swiss banks.