08/19/08 The Current Financial Crises Could Be Much Worse Than The Savings And Loan Meltdown Of The 1980's

Another bomb about to go off in the financial system?

Los Angeles Times

By Tom Petruno

All of the talk in the credit markets this week is that another big bomb is about to go off in the financial system.

That helped pull the stock market down today for a second session, led (again) by bank and brokerage stocks.

What kind of financial-system bomb? That’s the problem: The fear is very generic, not specific.

From the acrossthecurve bond-market blog by John Jansen:

Participants are poised for some sort of crack up and trade accordingly. They suspect that there is some crisis lurking in the wings and they are waiting for it to happen.

Notably, these jitters were intensifying last week, even before the weekend article in Barron’s magazine that effectively dug the grave for the common stocks of mortgage financiers Fannie Mae and Freddie Mac. Because their shares already have crashed in recent days, Fannie and Freddie don’t seem to fill the bill as potential market surprises, although they’re obviously adding to the heightened state of concern.

Michael Darda, economist at MKM Partners in Greenwich, Conn., notes that nervous investors have been demanding higher yields in recent days to buy high-quality mortgage-backed bonds and corporate bonds, widening the "spread" between those yields and Treasury bond yields.

"When the spreads widen out, there are stresses brewing" in the system, Darda says. "Previous surges have preceded bank failures or other collapses." As with the demise of Bear Stearns in March, for example.

Fears of a mega-failure were amplified today after Kenneth Rogoff, former chief economist at the International Monetary Fund and now a Harvard economics professor, predicted in a speech in Singapore that a huge U.S. bank was certain to collapse in the near future -- although, of course, he wasn’t naming names.

"The worst is yet to come," he said, according to the BBC. "We're not just going to see mid-sized banks go under in the next few months. We're going to see a whopper, we're going to see a big one, one of the big investment banks or big banks.

Given that kind of good cheer, it’s a wonder the credit markets are still functioning at all.

Yet Freddie Mac today sold $3 billion in five-year notes, and although the annualized yield of 4.17% was 1.13 points over five-year Treasury note yields -- the highest spread in at least 10 years, according to Bloomberg -- there was enough demand to get the deal done.

"Buyers still showed up," said Tony Crescenzi, bond market strategist at Miller, Tabak & Co. in New York.

The markets’ bad case of nerves may partly stem from memories of what happened a year ago this month. Just as much of Wall Street was packing up for summer vacation last August, the first major explosions occurred in what was to become the credit crunch.

That should remind us of something: In financial markets, it often works out that you get a crisis when nobody’s expecting one -- not when everybody’s looking for it.