Sunday, June 22, 2008

No Credit for You!

As the Universal Debt Bubble has begun to collapse under its own weight, various portions of the shadow banking sector have come under enormous pressure. These are the non-bank lenders that have magnified a credit bubble into the UDB. Starting last summer, the initial push shattered the most egregiously complex and levered structures - the CDOs. In the Fall of 2007, the conduits and SIVs joined the tankage - along with asset-backed commercial paper, their primary funding mechanism. The worst of the hedge funds have been closing their doors at an increasing rate.

Now we are beginning to see simpler securitized products being shunned as well. From Prudent Bear's Doug Noland:

Asset-Backed Securities (ABS) issuance slowed this week to $3.3bn. Year-to-date total US ABS issuance of $104bn (tallied by JPMorgan's Christopher Flanagan) is running at 27% of the comparable level from 2007. Home Equity ABS issuance of $303 million compares with 2007's $191bn. Year-to-date CDO issuance of $14bn compares to the year ago $217bn.

Over the past year, total CP has contracted $381bn, or 17.9%, with ABCP down $402bn, or 34.8%.


Credit Bubble Bulletin

As I read it, ABS (mostly credit card and auto loans) are down 73% from last year. Securitized home equity is down 99.8%. CDOs have fallen 93%. These were key shadow banking sectors that provided trillion during the last leg as the credit bubble mutated into the UDB. Because the structures were kept off the banks' balance sheets, they almost never had proper reserve structures. With leverage ratios of 30, 50 or even 100:1, the inherent risk was high. At 30:1, your valuation assumptions only have to be wrong by 3% for the whole thing to blow up - as they are now duly exploding.

Any hope that the Fed and other central banks had of keeping the asset bubble intact is fading along with the excess credit that has supported absurd asset prices for so long. The disappearance of the shadow banks is critical to the process of deflating the bubbles. At the same time as this illegitimate source of funding is drying up, the commercial banks are being forced to recognize large losses. Now the banks must lend within the restrictions of their required reserves and capital. At the same time, that capital is being wiped away by losses far faster than it can be replaced.

The math virtually guarantees that there will be a lot less credit available for the foreseeable future. Assets and goods that are dependent on the availability of credit are likely to see sharp further price declines.