The next credit crisis may be in low-rated corporate loans, that is, the kind that were used in the buyout boom during the past few years of such companies as Freescale Semiconductor and TXU Corporation. In the past week, these types of loans have plummeted in value and banks are expected to unload them in the next few days at "fire-sale prices." The Financial Stability Forum (made up of central bankers, etc.) met with G-7 nations this weekend and warned that this issue and the increasing uncertainty about securities may cause banks to further tighten credit and "choke off economic activity."
The market for leveraged loans to large U.S. companies with low-credit ratings is especially being hit hard now, as the interest rates on these holding are tied to short term interest rates. With the Fed cutting rates, investors are selling this type of debt as their payments are dwindling.
Securities known as CLOs, Collateralized Loan Obligations, pools of bank loans bundled together and sold to investors in pieces are facing big problems. Much like CDOs, Collateralized Debt Obligations that caused the problems in subprime mortgage loans, CLOs claim to spread the risk of default on this low-rated debt.
Standard & Poor reported that high risk corporate loans had fallen to record levels at the end of last week. It is not expected that the problems associated with these types of loans will be as severe as subprimes, but will contribute to the growing pile of shaky debts owned by banks. A major factor that is worsening the crisis in corporate loans is that investors bought some of these securities with borrowed money and as prices decline, they are forced to sell them at reduced prices, which in turn "magnifies the losses from rising defaults."
Problems are also increasing for money market investors who in the past have been big buyers of tax-free municipal bonds and student loans. They are becoming reluctant to buy these securities because "they fear the debt used to back the instruments will default or get downgraded by rating services. Goldman Sachs was unable sell enough of its hundred of millions of dollars in securities backed by student loans at their asking prices on Thursday and Friday. Because bond insurers such as MBIA, Ambac and Financial Guarantee are on the hook for billions of dollars in subprime securities, "their guarantees are no longer worth as much." This too presents a major problem, because more than half
of the nations municipal debt is guaranteed by bond insurers such as these.
It seems that both CLOs and CDOs have created havoc around the world in recent months. I realize that it is the obligation of investors to fully understand what they are buying. But, at the same time if a security is too complex or esoteric for seemingly educated individuals to understand, than perhaps these types of credit instruments should not be sold at all. IMHO, these securities have been about as helpful as launching a nuclear-tipped guided missile into the global economy.
New Hitches In Markets May Widen Credit Woes - WSJ.com