The debt nightmare is still with us
Pouring trillions of dollars into the global financial system has done more than pull the world away from the abyss.
It has convinced many to look again to well-worn signposts like major stock exchanges, currencies and sovereign debt to gauge where things are headed, rather than keeping their eye on credit markets to figure out where and when it will end. Take the attention being given today’s stock market rally.
This can be dangerous, however. Debt got the world into this mess, and though conditions have markedly improved thanks to the unprecedented support of global policy makers, it can still quickly quash optimism reigning among those taking their cues from the likes of Goldman Sachs and Intel.
The pull of traditional touchstones is powerful. Stocks, for one, are relatively easy to understand, and more importantly, easy to track. Credit can be hellish to get a full grasp on. It’s fractured, the gauges are many and the bellwethers keep changing. Yesterday it was short-term lending rates, today it’s corporate bond spreads and an index for commercial real estate.
And many investors, frankly, find it extremely boring — except, of course, when things blow up. Commercial real estate debt and municipal debt, the current trouble spots, don’t usually make the heart race, but they should.
Let’s take commercial real estate. While other credit markets have started shoveling out loans to solid and risky companies alike, financing for this $6.7 trillion market is all but dead. That’s not reassuring when you consider the amount of debt coming due — $300 billion to $500 billion this year.
That will further pressure already weak regional banks that dove deep into commercial real estate lending, as well as investors in the $700 billion bond market where such commercial loans are packaged and sold.
Richard Parkus, an analyst with Deutsche Bank, told lawmakers last week that total losses just for those holding commercial mortgage bonds could be between $65 billion and $90 billion, as many loans simply can’t be refinanced in the current environment of tighter lending standards and severely depressed real estate prices.
The expected losses in construction loans — those largely used to build homes and condos — are more severe. Parkus expects those to reach at least $140 billion, with local and regional banks bearing the brunt.
To be sure, government programs like the Term Asset-Backed Securities Loan Facility will help. It will begin accepting loan applications from investors holding legacy, or older CMBS, this week. The hope is this will eventually restart lending again, but so far no new deals in the United States have hit the market.
Then there’s the $2.7 trillion municipal debt market. So far, the market has been holding up relatively well considering the headlines coming out of California. Mutual funds are still plowing their money into this tax-exempt debt, lured by juicy yields on what was once considered a market for widows and orphans — it was so safe.
Yet, the potential for things to head south grows greater the longer California, one of the largest issuers of municipal debt, delays sorting out its $26.3 billion budget gap.
The stalemate has already stressed the state’s own outstanding bonds as its ratings move closer to junk status. On Tuesday, Moody’s Investors Service slashed the state’s ratings by two notches, bringing it to within three notches of junk.
It’s also raising the specter of possible government intervention, since a crumbling California isn’t good news for the still struggling national economy. Such a move, however, would create all kinds of uncertainty in the bond market, considering how debt holders elsewhere have been treated when someone needs saving.
Would debt holders be forced into some kind of debt for equity scheme where they’re handed a stake in Berkeley or San Quentin in exchange for wiping out the state’s bonds?
So be cheered by this week’s earnings report and perkier stock markets, but enjoy it while it lasts. The credit crisis is far from over; it’s only waiting to erupt again.