As we closed the books on July and prepared for a fresh start in August, this is a time of reflection. Many significant changes have occurred in which many people are calling the official beginnings of the full blown credit crisis. I thought that this would be a good time to look back over the past year and reflect where we were at this time last year and to the best of my ability try to figure out where do we go from here given the changed landscape. There is one thing that we all know is for certain: Wall Street will never be the same again in the fixed income markets. When I sat down to pen out the Subprime Woes piece on Feb 9, 2007 I never believed that the crisis would balloon out of proportion to what we see today. I never envisioned a major investment bank collapsing (I did rejoice when smaller mortgage originator shops collapsed, such as this piece: Pieces of the subprime market raining down on the town of Mortgageville!), I never envisioned entire segments of the fixed income markets literally ‘seizing up’, never envisioned Jim Cramer making a passionate ‘discussion’ about the credit crisis on CNBC. I never envisioned the thousands of colleagues on Wall Street who are now jobless.
There are simply some markets which I do not think will ever come back -- Auction Rate Securities is the prime example. An entire market propped up by the dealers on the Street that just vanished when they could not (or would not) back the integrity of the particular auctions.
I am going to highlight some of the major changes that has taken place in each of the markets that I am most familiar with over the past year just to share some general observations with you. I welcome feedback from the readers.
Mortgage Backed Securities Market
This market is still on heavy life support. Originations are down substantially as banks (finally) tightened their lending standards. What are we to do now? Where do we go from here? With Merrill’s announcement that they were selling CDO’s ~20c on the dollar, many people are quick to jump and say that we are nearing the end of the crisis. While we may be seeing a dim light at the end of the tunnel for this market, it is my belief that we are going to have to endure some more writedowns from the usual Wall Street suspects again. Lehman and Citi need to puke up a bit more. I do not expect that we will see the volumes in the MBS market return to any semblance of ‘normalcy’ (if you count 2001-2007 as being ‘normal’) within the next 5 years. The market will continue to trade, however and people with adequate capital who can hold on to these securities at these depressed levels could stand to make a pretty penny (i.e. buying around 0.20 and watching these MBS’s go to 0.30-0.40 within 1-2 years). Again, I stress that the banks will not stand to make profits (except for Goldman probably, since they have the ability to commit prop trading resources and mimic some of the hedge funds who have been buyers in this space)
Looking at national average mortgage prices, according to Bloomberg, 30yr fixed rates have not expanded too much over the past year, currently at 6.48%, up about 26 basis points from the previous year (6.22%).. However, if you look at just 6 months ago, the current levels are 99bps over where they were 6mos ago (5.49%)
1 Yr ARM is at 6.22, up 70 basis points since the same time last year and 117 basis points greater than 6 months ago.
Look at 15 Year fixed at 6.0%, same period last year we were at 5.9% for a modest 10bps increase.
What does this tell me? The MBS market is still under considerable strain, and we could see spreads widen out over the next 6 months.
Equity Derivatives Market
This market has been relatively quiet, according to sources on various derivatives desks in NYC, the primary focus has not been on performing dispersion trades, so that market has been fairly quiet.
In non-dispersion markets, volatility has remained pretty “high” compared to historical levels. I expect that VIX will remain above 20% for the remainder of the year. The market is still on edge regarding the solvency of a couple banks, and I don’t believe that the SEC or the Fed will be able to fully calm a panic or a run from the exits. As one trader put it “the landscape is still dry as a bone, and all it takes is one spark to cause another wildfire”
