Subprime woes make private equity, LBO deals and takeovers impossible

BEAR Stearns was only the tip of the iceberg. The subprime mortgage meltdown has now extended to the corporate bond and high yield loans markets, making private equity, LBO deals and takeovers impossible.

By Matein Khalid (Money Maze)

Published: Mon 13 Aug 2007, 9:08 AM

Last updated: Sat 4 Apr 2015, 9:21 PM

BNP Paribas, Goldman Sachs, Taiwan insurers, Australian asset managers, a German bank bailout, trauma in the commercial paper and leveraged loan markets, a bloodbath in the market for complicated credit derivatives that now only trade at 10-20 cents to the dollar because Wall Street dealer bids have vanished into thin air. As I had (somewhat prematurely) predicted in my New Years column “the coming global financial crash”, the world has sleepwalked into monetary Armageddon. When money markets lose 20 per cent of their NAV because their fund manager was dumb enough to buy “enhanced credit” toxic waste, no bank is safe from depositor panic, an electronic run on the bank in the Eurocurrency market. The shock waves of the global financial crash will reverberate all over the world, across all asset classes. The Fed’s monetary chickens have come home to roost. That much, at least, is certain.

Financial innovation on Wall Street, as with portfolio insurance on Black Monday, dotcom mania in Silicon Valley and Zaiteku in Eighties Japan, has once again doomed the world to a devastating crash, with many trillion destined to vanish forever in money heaven in the next few months. The rating agencies, the same dudes and dudettes who once pronounced Enron and the Kingdom of Thailand bonds a AAA rating just before the end, have now doomed thousands of investors worldwide who trusted their credit ratings to buy the CDO/CLO deals peddled by their Wall Street banks. The illusion of a AAA credit rating camouflaged the dirty little secret that most corporate bond new issues were junk, even CCC, the debt market equivalent of a landmine. But the capital markets alchemists of Wall Street took tranches of dangerously leveraged, risky debt (subprime, LBO loans, sovereign junk), pooled them in tranches of higher rated corporate CDO’s and sold them to gullible buyers like European, Asian and GCC banks desperate for a fixed income investment with a higher yield than Uncle Sam’s IOU (US Treasury bills, notes and bonds). There is a cosmic law that I have always respected in the universe. Zero plus zero still equals zero.

This was the reason I refused to invest one dirham in the complex CDO deals and structured finance products the bond brokers continually pitched the buy side here in the Gulf. I was appalled to learn that some Shariah scholars (on the payroll, of course) even permitted Islamic banks to buy highly speculative CDO’s and credit default swap baskets via special purpose vehicles that fool only those who desperately want to be fooled.

Of course, Wall Street pooled speculative debt tranches into CDO’s and CLO’s, earning multi-billion dollar bonuses in the process, selling them to banks, hedge funds, insurers and pension funds all over the world whose very existence is now at stake. After all, how often does the interbank market freeze in a liquidity crisis? A credit crunch can prove a macroeconomic nightmare, as lenders ration the supply of credit, not just its price. This was the grim lesson of the Great Depression, the Japanese lost decade in the 1990’s, the collapse of the Russia rouble and the Mexican peso. There is no doubt that the credit crunch will tip the US into recession.

After all, overleveraged economies with zero savings rates living on borrowed billions from offshore creditors have no real cushion for survival. I see weakness in the macro data the Bernanke Fed was clueless about at the last Federal Open Market Committee (FOMC). After all, why did private workweek hours and temp job growth fall in the last payroll number? Why did GM warn of lower auto sales? Why have sales tax receipts, proxies for consumption, plunged in Florida and California? Why has WTI and Brent crude oil fallen $8 a barrel? Why has ISM manufacturing and bank credit growth begun to slide? The real Fed Funds rate is now 300 basis points at a time when the world financial markets threaten to go ballistic with systemic risk. Do it, Chairman Bernanke. Do the right thing. Do it now. An intermeeting rate cut of 50 basis point. Do you want to go down in history as the monetary Nero who fiddled (not even a bias change at the last FOMC!) while Wall Street debt markets burnt? Credit crunches are all about fear. Remember FDR and the New Deal? The only thing we have to fear is fear itself and unlike FDR, we can measure the metrics of fear to the sixth decimal place. It is called the Chicago Volatility Index (VIX) and the VIX has almost tripled to 29 in six months. The money pump has now stopped pumping cash for homebuyers, LBO kings and junk bond deal makers. This is the lesson of the failure of banks to syndicate the LBO loans of KKR - Alliance Boots, First Data, and Chrysler-Cerberus, whose underwriters are saddled with $12 billion.

This was exactly the scenario I feared when I refused to buy the Blackstone IPO, even though I am a Pete Peterson acolyte ever since he ran Lehman Brothers, the reason I called the Blackstone IPO “leprosy on Wall Street” in my column. The poor investors in the Blackstone IPO have now lost 40 per cent of their capital. We are now living through the world’s first intercontinental credit crunch and its endgame sure will not be pretty. The capital markets can no longer price risk. The banking system can no longer finance borrowers, Investors in trillion dollar leveraged daisy chains can no longer exit their toxic waste loans, bonds and CDO’s. Since the idea of jumbo Eurobond loans or billion dollars IPO’s is now laughable, the equity market should replace El Toro with Abu Grizzly. Abu Grizzly is the father of all bear markets. He emerged from hibernation in late July, growled in August but he will kill in September. Remember, risk is a four letter word. But then so is ruin.