OVERLAND PARK, Kan. — In the April 18, 2007 edition of Credit Union Times, Brian Hague, CFA president/CEO of CNBS, LLC noted that the housing slump resulting from the subprime mortgage meltdown was gaining traction, and threatened the broader economy. There was no consensus then, but three months later the bandwagon is rather more crowded, Hague noted during a recent interview.
Just last week, the latest shoe dropped, with American Home Mortgage Investment Corp., the Melville, N.Y. lender's announcement that it doesn't have the cash to fund new loans, leaving thousands of waiting homebuyers stranded. Investment banks cut of its credit lines and it's expected the company will have to declare bankruptcy.
Hague said the events following the Bear, Stearns hedge funds, so heavily invested in subprime-backed bonds becoming valueless after being dubbed at near $1.5 billion, led to a sudden distaste for the collateralized debt obligation market. "CDOs are the slumgullion of the bond market," he said. "They are backed by other bonds that, in turn, might be backed by other types of collateral, including mortgages, and they made up the bulk of the Bear hedge fund's holdings."
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"These CDOs have been used by private equity firms to finance leveraged buyouts, so buying junk collateral led to more CDOs which helped to fuel a fairly good stock market this year," Hague observed. "Now, however, these private equity firms have become the Zack Mayo of the investment industry," (a reference to Richard Gere's character in the movie, An Officer and a Gentleman, when he tells his drill sergeant, "Sir, I have nowhere else to go!"). "These private equity firms have nowhere else to go either," said Hague.
When investors shy away from these relatively riskier bonds, he said, the ability to issue them dries up. "As a result, some 35 planned deals were shelved in recent weeks. This trend limits credit market access overall, with broad implications," he said. "At the top level, companies can't access the markets to raise funds for, among other things, buying other companies. But the trickle-down effect, through the broader bond market and on down to the consumer, will mean less readily available credit for everyone, and that will pose a drag on economic growth."
The stock market's roller coaster may not necessarily be a bad thing, he added. "The theory is that the stock market will be back to just trading on earnings instead of being like Las Vegas. There's a new flight to quality and if a sell off continues investors may move to Treasuries," said Hague. But every action has a reaction, and a rise in Treasury sales usually drives up the price, sending yields downward.
The historical perspective has it that an inverted yield curve presages a recession, but Hague thinks it's too early to say there will be one, but noted that this inverted yield curve is sure lasting a long time.
The other hobgoblin, of course, is inflation, which is being watched intently by The Federal Reserve. "Right now, the Fed's key inflation barometer is in a comfort zone. When it fell below that zone the last time, the Fed acted, starting to tighten things. Now they've been on hold for a year," he said.
"I've been amazed, really, that [Fed Chairman] Bernanke garners all the love he does for basically doing nothing. If you read between the lines of the Fed's statements, they essentially say they have no earthly clue of what to do so they do nothing. Everybody seems to love that, but I'm not so sure. I'm undecided if he's a good Fed chairman or not," said Hague.
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