Has the 'Credit Crunch' Arrived?

Over at The Big Picture, Barry Ritholtz says that we've now entered the great credit contraction long-anticipated on many of the financial blogs I follow. Time will tell whether he and others are right. Still, it proves hard to disagree with him after yesterday's Wall Street blues and continuing media 'bad news' re: housing, subprime and cousins, and trouble in derivatives/hedge fund land. Ritholtz:

The Great Credit Contraction of 2007
[Barry Ritholtz, via The Big Picture]

What is the inter-relationship between Housing, LBOs & Stock Buybacks?

Last month, I noted 6 reasons why rising yields were a threat to equity prices:

Valuation
The M&A/LBO Put
Competition
Profits
Share buybacks
Consumer spending

As of late, we have seen the threat of two of these issues increase dramatically: The M&A/LBO Put and Share buybacks are being pressured by the increasingly expensive credit. 

Much of this is derived from the mess in Housing: As many of the ARM/liar loans in the Sub-prime and Alt-A mortgage group increase their default rates, the residential mortgae backed securities (RMBS) that were packaged into CDOs have begun to unravel (See WTF is going on in the ABX Markets?). All told, the many variations of these were a prime source of cheap financing. This was what has been driving private equity buying frenzy and many share buybacks. That financing source is rapidly fading. 

How much is the credit drying up?  According Merrill's Richard Bernstein:

"Bloomberg Radio reported this morning that the monthly issuance of Collateralized Debt Obligations (CDOs), or packages of debt instruments bundled together to form a "portfolio" of debt, dropped from $42 billion to $3 billion in the latest month. That 93% drop represents a significant tightening of liquidity that is starting to ripple throughout the credit markets. The fixed-income markets appear to be starting to understand that the days of free-flowing liquidity are likely to be behind us. Most credit spreads are widening."

See Bill Gross latest for further discussion of the great credit contraction of 2007. 

Lastly, for those hoping this marks the bottom of the Housing derived credit crunch, according to the UK Telegraph, "some $2 trillion of subprime and 'Alt A'  mortgage debt is falsely priced on the books of banks and funds worldwide.” 

And to imagine: Some tv pundits -- cretins of the lowest order -- actually have been insisting that the Housing market would have absolutely zero impact on credit, the economy, markets and retail.   What a bunch of tools . . .

And don't miss Already Baked In and Contained? from Russ Winter, deriding those who continue to tell us that the 'subprime mess' and related mortgage and corporate debt problems are "well-contained". Winter's post includes this gem from the LA Times:

… Foreclosures soared to 17,408 for the three months ended June 30, an increase of 799% from the same period last year. The current rate handily exceeds the previous foreclosure peak set in 1996, when the state was in the final throes of a six-year slump. …

Stay Tuned! Not to me, but to the blogs and sites on my sidebar.

UPDATE: Related: Robert Shiller explains how the phrase "awash with liquidity" has changed in recent years:

The Liquidity Puzzle
Robert J. Shiller

We increasingly hear that “the world is awash with liquidity,” and that this justifies expecting asset prices to continue rising. But what does such liquidity mean, and is there really reason to expect that it will sustain further increases in stock and real estate prices? …

Traditionally, “awash with liquidity” would suggest that the world’s central banks are expanding the money supply too much, causing too much money chasing too few goods. But if that were the problem, one would cause all prices – including, say, clothing and haircuts – to rise. That is what the Federal Reserve Chairman Arthur Burns meant when he said that the United States was “awash with liquidity” in 1971, a period when the concern was general inflation. …

Hyun Song Shin of Princeton University proposed a theory of excess liquidity in a paper with Tobias Adrian that he presented last month at the Bank for International Settlements in Brunnen, Switzerland. He says that it merely reflects a feedback mechanism that is always present: any initial upward shock to asset prices strengthens the balance sheets of financial institutions, so in response they borrow more and bid up prices even more.

But if that is what the term “awash with liquidity” means, then its widespread use today is simply a reflection of the high asset prices that we already have. It could even be called an approximate synonym for “bubbly.”

The term “awash with liquidity” was last in vogue just before the US stock market crash of October 19, 1987, the biggest one-day price drop in world history. The reasons for that crash are complex, but, as I discovered in my questionnaire survey a week later, it would appear that people ultimately did not trust the market’s level. As a result, they were interested in strategies – such as the portfolio insurance strategies that were popular at the time – that would allow them to exit the market fast.

The term “awash with liquidity” was also used often in 1999 and 2000, just before the major peak in the stock market. So its popular use seems not to reflect anything we can put our finger on, but instead a general feeling that markets are bubbly and a lack of confidence in their levels. Under this interpretation, the term’s popularity is a source of concern: it may indicate a market psychology that could lead to downward volatility in prices.

We are now, or were until very recently, awash with credit liquidity, which comes as no surprise to those of us who think Hyman Minsky and successors understand (and extend) Keynes correctly.