Right now there are investment managers working out what exposure they have, whether they need to sell, and whether they need to disclose the position.
Where to from here?
However chaotic the financial markets have been over the last few weeks, there is very little sign of disturbance elsewhere.
Ms and Mr Average-Citizen are probably most aware of the gyrations of the sharemarket as reported on the TV news bulletins, but not much has changed in their day-to-day lives.
There may even be some readers – initially surprised that anything short of world war could shake your correspondent from his weekend torpor to prepare a blog for a Monday – thinking to themselves: well, what was all that fuss about?
It is certainly true that the panic has eased – but we are still very much in the middle of things.
At the moment, corporate borrowers are issuing very short-term paper – seven and 14 day terms rather than the 60 and 90 day terms of before. This is because they see rates as unnaturally high and don’t want to lock in for a day longer than they must. Dealers are cautious about what they’ll take to the market. They want truly prime deals, and nothing too big.
So the dealers don’t trust the market to cope with big licks of debt, and the borrowers think the rates are “wrong”. To me that describes a market that is somewhere between unsettled and dysfunctional.
I hold to the view that there will be a general permanent step up in rates, reflecting an increase in the risk premium that investors demand. My guess is that for prime borrowers it will be less than 0.25% (25 points), and quite possibly around 10 points. For sub-prime and low-doc borrowers it will be considerably more, however less they are able to provide a great deal of security.
Absent further shocks, however, there is a reasonable case for saying that the liquidity market has hit bottom and is slowly and steadily improving.
The equity and investment markets are another story. As I explained in my earlier piece, the market price of some of the investments in collateralised debt obligations (CDOs) is zero – notwithstanding that the intrinsic value of the CDOs is quite high.
The fund managers currently holding CDO investments will crystallise huge losses if they are forced to sell before there is any recovery in price (the intrinsic value explains why some of the large finance houses are bailing out some of their funds – they reasonably expect to recover the value of the investments over time).
Now, securitisation allows debt to be sold and on-sold. CDO funds buy and sell debt, and some CDO funds buy and sell CDO funds. The sum total of all of this is that the billions and billions of dollars of paper losses could be anywhere.
Right now there are investment managers working out what exposure they have, whether they need to sell, and whether they need to disclose the position. I expect a regular flow of write-down announcements, and Ms and Mr Average-Citizen will discover that 1% or 2% or 5% of their superannuation is actually invested in CDOs or similar vehicles.
Now, to the question I was asked earlier this week: should we be getting into RAMS or staying clear?
(But first disclosure: neither BoLR, his family, his alter ego, nor his alter ego’s family hold shares in RAMS.)
I expect RAMS to be affected by the same general step up in rates as every one else. Its profits will be unaffected if it can pass the increase on without losing market share. The founder (and still majority shareholder) John Kinghorn is cashed up and very knowledgeable about the business and the industry. If he loads up in a big way then I would consider buying – but not otherwise.
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