Uncertainty Over Rescue Intensifies Credit Crisis
By LIZ RAPPAPORT, SERENA NG and PETER LATTMAN
A slew of new data suggests the effects of the credit crisis are ricocheting around the globe as lenders grow increasingly distrustful of their own customers and each other.
In both the U.S. and Europe, uncertainty about the ability of governments to push through comprehensive financial-system rescue plans continued to weigh on bond and stock markets. On Thursday, the rate on government debt maturing in three months fell to just 0.6% -- indicating investors are willing to accept low returns simply to avoid the risk of losing their principal.
The most worrying aspect of the crisis is a growing reluctance among financial institutions to offer basic loans that are the lifeblood of the economic system. The Federal Reserve said Thursday the situation had worsened over the past week. Its data showed lenders reduced short-term loans to companies by a record $94.9 billion, bringing the total decline to $208 billion over the past three weeks.'
These loans, known as "commercial paper," run anywhere from a few days to three months, and are routinely used by businesses of all stripes to fund day-to-day operations -- paying the bills, meeting salaries. The market for these loans, which totaled $2.2 trillion last summer, has shrunk to $1.6 trillion.'
"It's unprecedented to see the markets shut to so many firms at one time," says Peter Andersen, a portfolio manager at Congress Asset Management Co., an investment company in Boston.
Indeed, this week, General Electric Co., long hailed as one of the steadiest companies in America, was forced to raise billions of dollars of capital on onerous terms partly because investors in GE's short-term corporate debt fretted about its rising borrowing costs. On Wednesday, a money fund catering to educational institutions froze withdrawals -- sending more than 1,000 colleges and schools scrambling to ensure they have cash to pay teachers and cover expenses.
The credit crunch is intensifying in Europe's financial sector. Since last weekend, governments have stepped in to prop up several troubled banks including Fortis NV, Bradford & Bingley PLC and Dexia SA. The problems have also prompted Ireland to guarantee the deposits of its six biggest banks.
And in recent days, troubles in London at Sigma Finance Corp., a $27 billion investment fund run by the investment firm Gordian Knot Ltd., rippled through the credit markets world-wide. On Thursday, Swiss insurance company Zurich Financial Services AG warned it will have to take a $275 million write-down due to investments in Sigma, which racked up losses on bonds issued by banks including Lehman Brothers Holdings Inc.
Concerns about the state of U.S. financial infrastructure sent stock prices sharply lower on Thursday, with the Dow Jones Industrial Average slipping 3.2%. Stock prices, however, offer only an indirect view of the crisis roiling debt markets.
The fresh Fed data showed, for instance, the extent to which lenders are unwilling to part with their money except for brief periods. The amount of debt that must be paid back in one to four days nearly doubled, to around $160 billion, since the start of September. By contrast, debt maturing in more than 81 days fell to $3 billion from $13.5 billion at the start of the month.
The value of many loans and bonds has fallen dramatically. Prices of investment-grade bonds slumped 7% last month alone, while the so-called "junk bond" market (where weaker companies borrow) had its biggest decline in 20 years last month.
Annual yields on junk bonds are now above 15%, up from 11% just three months ago.
Bankers are also recoiling from making regular loans to companies perceived as riskier bets. The value of loans to companies like these -- which used to be considered relatively stable investments, because they are backed by assets like buildings and equipment -- has fallen more than ever before to record lows.
Overall, the amount of money loaned to companies in the form of "syndicated" loans (generally larger loans arranged by teams of banks) has dropped 40% in the first nine months of this year, to $2.31 trillion, according to Dealogic, a financial-data service.
The financial-system rescue bill currently before Congress attempts to address some of these issues by, among other things, empowering the Treasury to purchase up to $700 billion of poorly performing mortgage-related securities and other assets that have caused losses and a broad swath of financial institutions. The bill, which also includes tax cuts and an increase in the amount of federal insurance coverage on bank deposits, is designed to shore up financial firms and give them increased flexibility to get back to the business of borrowing and lending.
The legislation is scheduled for a vote before the House of Representatives on Friday, after passing the Senate late Wednesday.
However, the House firmly rejected an earlier rescue package on Monday. Since then, investors have continued to express their concern.
This week, they focused on the life-insurance industry, with shares of Hartford Financial, one of the nation's biggest insurers, falling 54% in four days. Concerns are centered on the company's investment portfolios and their need for cash, though neither appear to be at critical levels.
Many of the problems are in types of investments that have long been considered almost as safe as cash, but haven't turned out to be. As a result, investors are pushing into ever-safer types of investments, such as government bonds or bank deposits, to minimize the risk of losses.
The collapse of Lehman Brothers Holdings Inc. exposed a new set of risks in supposedly safe debt markets. When a major money-market fund -- a type of investment considered to be almost as safe as cash -- shut down last month after a big loss on Lehman bonds, it sent fresh shock waves through the lending community.
"Underlying it all is just a breakdown of ordinary banking, the nuts and bolts of the credit markets," said Martin Fridson, a 25-year bond-market analyst and head of Fridson Investment Advisors.
In some respects, all this represents a classic tightening of lending that has accompanied every credit crisis. But it's worsened this time by the explosion in recent years of new types of specialized investments that now are increasingly tough to put a value on. These types of complex investments also had the effect of drawing investors world-wide into complicated financial relationships that are only now starting to be disentangled.
The troubled London fund, Sigma, is a case in point. Investors, worried that Sigma might be forced to sell billions of dollars worth of bonds, sending their prices down, this week raced to buy "credit default swaps" -- a type of insurance against bond defaults or plummeting prices -- on financial-company debt.
The volume of trading in swaps covering the debt of giant lender GE Capital was double its normal total on Wednesday, traders say. Prices rocketed higher on Wednesday, costing investors more than $700,000 annually for five years of insurance on $10 million of GE Capital debt. A month ago, the same protection cost only $160,000.
In the midst of this crisis, GE announced a deal in which Warren Buffett injected $3 billion in preferred stock, yielding 10%. The company says it will sell $12 billion in common stock to other investors as well.
It's not just swaps and other complex investments that are causing ripple effects in markets world-wide. In a report on Thursday, analysts from J.P. Morgan said they believe the investor pullback in the U.S. commercial-paper market "is a contributing factor in the recent wave" of financial woes at European banks.
—Cynthia Koons contributed to this article.Write to Liz Rappaport at liz.rappaport@wsj.com, Serena Ng at serena.ng@wsj.com and Peter Lattman at peter.lattman@wsj.com |
