The same thing is happening to mortgage-backed paper these days. Defaults are rising, ratings are cut, market values keep coming down, but banks and hedge funds are stubbornly hanging on to their nuts. Bernanke cut rates and they took the SIV's onto their own balance sheets - and still there was trouble. The next ploy was to try and set up "separate" entities that would buy the paper from the banks at a slight discount, financed by the self-same banks. They call this an arm's length transaction, but it's their own arm inside the box holding on to the lychee for dear life. Now they are "negotiating" with the Treasury Dept. to find ways to revive the ABCP market.
Meanwhile, the market is clubbing away at their head. Week after week the amounts of ABCP outstanding are dropping and their yields are stuck high, while ABX indexes are melting away.
ABCP outstanding as of Wednesday, Oct. 10. (yellow line). Plunging still...
Charts: Federal Reserve
CP risk spreads have come down somewhat from their panicky highs, but are still very wide and getting sticky around 55-60 b.p. - unlike previous spike episodes. This is not comforting at all.
Absolute yields have come down, but once again ABCP rates refuse to go below where they were before the Fed's rate cut. For mortgage-backed traders/speculators those 50 bp never happened. Maybe the arbi desks will jump in and close the spreads, but... in which direction? Because if they end up also raising the rates paid by the financial firms (red line), it will be a Pyrrhic victory.
Even the newest vintages of ABX are weakening once again.
And how could they not? The real estate boom has turned into a bust, the economy is slowing and mortgages made under rosier-than-thou assumptions are simply not performing according to model. And they are certainly not performing as hoped.
Let go of the nut, Cheeta. That's not Tarzan you see coming at 'ya.