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Is Credit On The Verge Of An Oversaturation "Perfect Storm" Implosion

Tyler Durden's picture


Something quite disturbing happened during today's latest attempt by the Fed to sell $3.8 billion in face amount of Maiden Lane 2 assets: it had a busted dutch auction. In fact, the auction was so massively busted, the New York Fed managed to sell only half of the bonds for sale, or $1.898 billion in 36 Cusips of the total 73 Cusips offered for sale. Suddenly, the Fed's attempts to sale piecemeal portions of the $31 billion Maiden Lane II portfolio that was offered to be repurchased by AIG, and subsequently was offered for open auction as Zero Hedge first suggested, is starting to backfire, after a month ago several traders complained that instead of "dribbling" out small piece of the portfolio (the previous average auction block notional for sale was under $1 billion). As per Housing Wire from May 17, which cited a complaint by an MBS trader: "if you charge ahead and bleed out one or two lists a week for the next
10 to 12 weeks, prices will continue to go lower, and in the interest of
maximizing value for the taxpayer, I think it is time to re-engage the
large portfolio bid you had or make available to other counterparties
the ability to bid large chunks of what you have left to sell." Well, the trader got what he wanted... And in the process may have blown up the credit market. As Bloomberg reports, "Federal Reserve auctions of mortgage securities that the central bank assumed in the rescue of American International Group Inc. are fueling a selloff in credit markets as Wall Street rushes to hedge against losses on stockpiled debt." Sure enough, someone focusing on the equity market may be completely oblivious to the devastation that has been unleashed on HY and IG traders: "Declines in credit-default swaps indexes used to protect against losses on subprime housing debt and commercial mortgages accelerated this month, reaching almost 20 percent in the past five weeks as the cost of the insurance climbs, according to Markit Group Ltd. The plunge this week started infecting everything from junk bonds to the debt of financial companies." And while as Bloomberg points out that there is a confluence of technical and fundamental factors affecting credit sentiment,  "You almost have a perfect storm of events,” said Shah of AllianceBernstein. “You have both the fundamental justifications for the market going lower and you have the technicals being created by Maiden Lane” there is a far scarier implication. If dealers and funds are unable to handle a mere $31 billion MBS portfolio disposition, and its weekly sale (think of its as a reverse repo) is starting to cause massive ripples in the bond market, just what will happen when dealers are forced to hold back the tens of billions in weekly bond auctions they freely flip back to the Fed now. In other words, is the credit market on the verge of a oversaturation implosion (hence the title)?

A quick glance at the performance of the 5 CMBX AAA vintages over the past year demonstrates that unlike equities, credit, especially of the resi-backstopped variety, already is plumbing year lows:

More from Bloomberg on this very precarious position in the credit market:

The central bank, which this month plans to conclude its purchases of $600 billion of Treasuries in a program meant to bolster markets, had typically been offering about $1 billion from its Maiden Lane II portfolio once or twice a week until early May. In its ninth auction yesterday, the first since May 19, the New York Fed offered $3.8 billion of debt. Investors presented accepted bids for $1.9 billion, the smallest share yet.

“The manner in which the sale of the Maiden Lane II portfolio has been conducted put the market in a vulnerable state,” said Bryan Whalen, the co-head of mortgage-backed bonds at Los Angeles-based TCW Group Inc., which oversees $120 billion in assets. Falling mortgage swap indexes and bond prices are “reflective of levered money, dealers especially, taking risk off the table, which is feeding on itself,” he said.

Jack Gutt, a spokesman for the New York Fed, declined to comment.

One Markit ABX index tied to subprime mortgage bonds that were rated AAA when issued in 2006 has dropped to 47.2 from 58.8 on April 1, declining from a more than two-year high of 62.7 on Feb. 15. A similar index tied to junior AAA ranked commercial- mortgage bonds created in 2007, known as the Markit CMBX, has plunged to 68.7 from 80.4 at the start of April and more than two-year high of 85 on Feb. 15.

“I imagine the original $15.7 billion bid from AIG would be looking pretty good right now,” said Clayton DeGiacinto, who manages about $200 million as chief investment officer of New York-based hedge fund Axonic Capital LLC.

Don't worry Clayton, AIG is now focusing on buying up Europe's toxic sludge... Somehow we think you are happier it is AIG who is forced to bid it up and not you. Oh wait:

Investors are also bracing for more sales from non-U.S. banks after Dexia SA on May 27 said that it would take a charge to accelerate its sales of toxic holdings, including $8.5 billion of home-loan securities, DeGiacinto said. “Europe has never gone through the disgorging process that we’ve gone through here,” he said.

As for why we believe there is massive oversaturation with credit holdings, and why the end of QE2 is about to expose everyone who has been swimming without a bathing suit:

Primary dealers’ holdings of fixed-income assets including corporate debt, commercial-mortgage bonds and home-loan securities without government-backed guarantees swelled to $94.9 billion in the week ended May 25, according to Fed data. That total, which includes only notes maturing in more than one year, was up from $85.7 billion at the end of 2010 and a six-year low of $59.8 billion in April 2009.

The drop in the mortgage-bond markets began spilling over to corporate credit, which already had started to weaken from the deteriorating economic picture and disagreement among European leaders over who should bear the burden of rescuing deficit-plagued governments including Greece.

“Somebody who trades these indexes sees that kind of movement in CMBX and reacts,” Angelo & Gordon’s Solomon said. “That is the mechanism that leads these indexes lower.”

Default swaps on the six largest U.S. banks have gained an average of 19.4 basis points to 137.2 basis points since May 31, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Apparently the topic is so disturbing to the PD and hedgie community they even got the WSJ to promptly post an identical article to Bloomberg's minutes after.

Bottom line, unless someone opens up a release valve, we are about to see a massive regurgitation and even more massive repricing of credit risk, first in IG, then in HY and ABX/CMBX, and lastly, and most massively, in equities, which continue to exist in their own world and which are now totally disconnected with HY, which they used to track so very closely.

And lastly, in perhaps the most ominous news, the rates legend, the former head of Merrill's RatesLab, Harley Bassman, who recently moved to the prop side, has decided to call it a day.

Farewell Merrill Lynch…..

Today marks my twenty sixth year at Merrill Lynch; so it is with strong feelings that I inform you that I am retiring from the firm.
I will always bleed Merrill blue and I thank the firm for allowing me the freedom and support to build out new ideas. 
Mostly, I will miss all of you.  How lucky I have been to be able to engage daily with such clever and brilliant people.  Every success I have achieved stood upon your shoulders.

As per some final trading advise:
1) It is never different this time, and
2) The Greeks had it right 2500 years ago, it is all about character. 

As this chapter closes, so another will open - I can only hope it will be as great. 
Harley Bassman
The Convexity Maven

Good luck Harley... And yet we can't help but wonder - just what spooked one of the oldest veterans in the rates space to pull the plug, in the middle of the year, a time when traders are more focused on the Hamptons than on transitions...


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Fri, 06/10/2011 - 01:58 | 1357060 I think I need ...
I think I need to buy a gun's picture

gold revaluation by 7/1/11....this looks like a reset...

Fri, 06/10/2011 - 02:00 | 1357061 HungrySeagull
HungrySeagull's picture

When the Veterans are getting out by any means possible, including retirement... they are already speaking loudly without too many words that they are getting out while it is good.

Its the same as hunting. Make the kill, collect the good meats fast and be gone within the hour before Grizzly and Brown bears show up to contest you for the kill. They can close 20+ yards faster than you can load and make ready.


The sun is coming up, everyone is busy looting the junk yard and it wont be long before the dogs will start catching the slowest of the bunch struggling to make it to the outer fence.

Fri, 06/10/2011 - 02:10 | 1357072 Michael
Michael's picture

I love the smell of debt saturation in the morning.

Fri, 06/10/2011 - 07:13 | 1357251 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

It smells like self-destruction!

Fri, 06/10/2011 - 03:26 | 1357103 PhattyBuoy
PhattyBuoy's picture

+ PD bagholders

Fri, 06/10/2011 - 02:09 | 1357067 phungus_mungus
phungus_mungus's picture

Anyone up for a good game of shuffle board on the deck of the Titanic before she goes under for the last time? 

Fri, 06/10/2011 - 02:07 | 1357069 jmw_hobbes
jmw_hobbes's picture

reval as in up or down?

Fri, 06/10/2011 - 02:09 | 1357071 FreedomGuy
FreedomGuy's picture

For a nontrader, what is the result of all these things in terms of interest rates, credit availability, etc. for the general public?

Fri, 06/10/2011 - 06:51 | 1357229 equity_momo
equity_momo's picture

Put it this way , you might aswell take a loan out against your 401k and spend it on whatever is tangible now. Because all paper is going to burn , even the USD after it has one last , debt deflating gurgling rally.  Pensions? SS ? Stocks ? Bonds ? Fiat ?  It'll look like that inferno in Arizona.

Fri, 06/10/2011 - 10:16 | 1357732 RafterManFMJ
RafterManFMJ's picture

Aaaaaaaoooooooogaaaa! Aaaaaaaaaaoooooooooogaaaa!

Just requested MAX I can get out of my 401K. Paperwork inbound...

Fri, 06/10/2011 - 02:15 | 1357074 slow_roast
slow_roast's picture

A massive plunge appears imminent; the USD will rally and everything will suck wind.

Fri, 06/10/2011 - 02:19 | 1357077 zaknick
zaknick's picture

Please let this be the big one! Let me see the US become completely unglued!

Reap that whirlwind, bitchez!

Fri, 06/10/2011 - 02:33 | 1357084 JLee2027
JLee2027's picture

It would not be "just the US".  And if anything, the US will be the last man standing.

Fri, 06/10/2011 - 03:12 | 1357097 slaughterer
slaughterer's picture

Who composes the team at Black Rock Solutions who is selling this junk?  Are they disclosing all the risks associated with owning this junk leftover from the last crash?  Or do we have to send Carl Levin after them?

Fri, 06/10/2011 - 03:45 | 1357121 Yen Cross
Yen Cross's picture

 Over saturation? Wall streets next callword?


                  What a joke.   Yen (dot)

Fri, 06/10/2011 - 03:55 | 1357125 jtaskinen
jtaskinen's picture

About debt, one thing has been bothering.

Obama budget deficit 1600bn

War in Libya 2011 750bn

Stimulus 2011 300bn?

Slowing economy 300bn?

Total deficit 2011 circa 2.5-3 tr?

War in Libya could not have been included in the Obama budget in March, so the yestersdays number in FT needs to be added to the original deficit of 1600bn? On top of this we need to add the planned stimulus plus effect of slowing economy, I just gussed that each item would contribute 300bn.

Can this be anywhere near the truth?

Fri, 06/10/2011 - 04:02 | 1357135 asdasmos
asdasmos's picture

"War in Libya 2011 750bn"


You sure you got that right?

Fri, 06/10/2011 - 04:07 | 1357140 Yen Cross
Yen Cross's picture

NATO loosers is more appropriate!

Fri, 06/10/2011 - 04:32 | 1357156 jtaskinen
Fri, 06/10/2011 - 04:41 | 1357165 asdasmos
asdasmos's picture

"US military operations in Libya are on course to cost hundreds of millions of dollars more than the Pentagon estimated, according to figures obtained by the Financial Times.

Robert Gates, the outgoing secretary of defence, said last month that the Pentagon expected to spend “somewhere in the ball park of $750m” in the 2011 fiscal year as part of efforts to protect the Libyan people."


Indeed. That would be million, not billion.

Fri, 06/10/2011 - 04:32 | 1357157 jtaskinen
Fri, 06/10/2011 - 11:19 | 1357976 mickeyman
mickeyman's picture

Obama budget deficit 1600bn

War in Libya 2011 750bn

Stimulus 2011 300bn?

Slowing economy 300bn?

Total deficit 2011 circa 2.5-3 tr?


You forgot to add 

End of the fiat currency system . . . priceless

Fri, 06/10/2011 - 04:05 | 1357132 asdasmos
asdasmos's picture

"1) It is never different this time"


I wonder if he is referring to Bernanke's playbook...

Fri, 06/10/2011 - 04:01 | 1357134 litoralkey
litoralkey's picture

Several of those CUSIPS are f**ked, and have 0 real dollar value.

THe CUSIPs had been held back from prior auctions, but they had to be jettisoned at some point.

Fri, 06/10/2011 - 04:27 | 1357150 Henry Chinaski
Henry Chinaski's picture

Great post.  One word summary: Ponzi

Around here, we don't skinny dip. We chunky dunk.

Good advice from Harley


Fri, 06/10/2011 - 04:28 | 1357154 Yen Cross
Yen Cross's picture

 Typical FROG. Junking me.

Fri, 06/10/2011 - 20:27 | 1360179 GoinFawr
GoinFawr's picture

Hey! (Grin)

Fri, 06/10/2011 - 04:52 | 1357173 juujuuuujj
juujuuuujj's picture

Welcome to debt deflation. Steve Keen said it first.

Fri, 06/10/2011 - 04:52 | 1357177 BlackholeDivestment
BlackholeDivestment's picture

...sure seems to be a lot of stormy weather hitting more often and with more frequency (HFT lol) and higher intensity ...lately. Rats leaving political office too. It's as if it's 2112 ...uh, oh yeah.

Fri, 06/10/2011 - 05:32 | 1357197 dolly madison
dolly madison's picture


Fri, 06/10/2011 - 04:55 | 1357178 Arkadaba
Fri, 06/10/2011 - 06:09 | 1357218 BlackholeDivestment
BlackholeDivestment's picture

...sounds real good loud, I needed that.

Thanks man...

Fri, 06/10/2011 - 06:36 | 1357225 Arkadaba
Fri, 06/10/2011 - 20:18 | 1360149 Arkadaba
Arkadaba's picture

I would love to see a google map of their route. Early Canadian punk band. 

And not man - grrl

Fri, 06/10/2011 - 07:14 | 1357250 JuicedGamma
JuicedGamma's picture

Theres nothing better than self locomoted speed thrills.

Fri, 06/10/2011 - 05:18 | 1357185 johngaltfla
johngaltfla's picture

And thus how the liquidity crisis will evolve. As the Fed liquidates its portfolio of crap, the valuation of the crap the banksters have been holding as "Tier 1 Capital" will decline at the same time the Fed demands they increase their capital requirements. The banksters will begin liquidating their equity and commodity portfolios and attempting to sell their junk bonds in a panic which only accelerates the process of asset price deterioration and feeds on itself.

As pointed out in these pages on ZH and elsewhere, it has never been a liquidity crisis, this was a solvency crisis. This is exactly what Chris Whalen at IRA has been warning about. Now those banksters and institutions (insurance companies and pension programs included) who claimed to have strong balance sheets will now be exposed because they have little to no cash flow along with deteriorating asset quality.

Gee, who'd of thunk it.

Fri, 06/10/2011 - 05:36 | 1357203 johngaltfla
johngaltfla's picture

and in a related story about bond auction failures from Europe (Via the WSJ)....

Bond Deal May Augur More European Travails

Fri, 06/10/2011 - 05:20 | 1357186 irishlink
irishlink's picture

What going to happen to all those poor people who ran out of stocks and into coporates and government bonds? Frying pan into the fire and then some.

Fri, 06/10/2011 - 05:21 | 1357187 Withdrawn Sanction
Withdrawn Sanction's picture

$1.9 B of $3.8 in face...what were the prices fetched?  That will tell us the relative quality of the issues sold, and by implication the value of those not sold.  This is the real garbabe in the Fed's Bear portfolio; is it any wonder no one wants it?

Fri, 06/10/2011 - 05:30 | 1357194 mberry8870
mberry8870's picture

Remember the ARS market in 2007-2008? 

Fri, 06/10/2011 - 05:32 | 1357198 johngaltfla
johngaltfla's picture

Hell, remember the MBS market in 2007-2008....

Fri, 06/10/2011 - 06:11 | 1357219 mberry8870
mberry8870's picture

True, but my point is that much like this market the ARS market was the "lubricant" needed to facilitate the continuing "malinvestments" in other markets e.g. the MBS in '07-'08 and equities today. This ain't going to end well.

Fri, 06/10/2011 - 05:47 | 1357208 Coke and Hookers
Coke and Hookers's picture

Gee well this week the Icelandic government sold $1 billion in bonds, mostly to US investors. The issue was at least 100% oversubscribed from what I understand. I think it says a lot about risk perception in the market now towards the US when bonds from bankrupt rock in the Atlantic sell like hotcakes while the almighty fed can't unload their junk.

Fri, 06/10/2011 - 10:19 | 1357730 epwpixieq-1
epwpixieq-1's picture

Considering that energy prices are and will be on the rise, Icelandic government bonds may good investment/hedge, especially considering that virtually all of the Iceland's electrical energy is produced by renewable resources.

Fri, 06/10/2011 - 07:08 | 1357245 eddiebe
eddiebe's picture

Managed take-down so the elite can squeeze some more blood. Then they'll come to our rescue and take away the rest of our freedoms and options.

Better join the Storm troopers now, or get wiped out by them.

Fri, 06/10/2011 - 08:38 | 1357378 Bob
Bob's picture

Looks that way to me as well.  No surprise, of couse, that's how the system is set up.  They'll rescue us and leave it to their sycophants and useful idiots to fight off the "populist hoards" of entitlement-drunk "mouth-breathing socialists" demanding retribution, of which appropriately focused and severe taxation would be the quickest and simplest, and there will be further deterioration of the real economy and cuts in the social safety net while those sycophants and useful idiots lick clean the plates bussed from the banksters' tables.

Fri, 06/10/2011 - 07:42 | 1357277 oogs66
oogs66's picture

CNBC just mentioned CMBX

Fri, 06/10/2011 - 08:18 | 1357349 Re-Discovery
Re-Discovery's picture

Just wait until this collateral gets rejected for the overnight markets (if its being accepted now which you know some of it is.)

Fri, 06/10/2011 - 08:32 | 1357373 spinone
spinone's picture

This failure was intentional. The FED is the bad bank. It will be wound down over the next few years, once the dollar is no longer profitable for the FED stockholders.

Fri, 06/10/2011 - 08:42 | 1357398 Boston
Boston's picture

Bottom line, unless someone opens up a release valve, we are about to see a massive regurgitation and even more massive repricing of credit risk, first in IG, then in HY and ABX/CMBX, and lastly, and most massively, in equities

Exactly.  And when this repricing accelerates into an stampede out of risk, WHERE do you suppose much of this scared money will flow into?

Hint:  it rhymes with US Smeasuries.


Fri, 06/10/2011 - 09:11 | 1357502 snowball777
snowball777's picture


Fri, 06/10/2011 - 11:42 | 1358065 I did it by Occident
I did it by Occident's picture


keeping those rates low, bitchez!

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