The Absolute View

Today, there was a Bloomberg article highlighting that the cost Bear Stearns' and Lehman's debt is higher than the debt of the Republic of Colombia. In case you've been under a rock the last few months, the primary concern of the markets has been the exposure US sub-prime mortgages, not how a forty-year-old civil war versus drug lords has been going. It shouldn't be surprising that BSC and LEH are under pressure, rightly or wrongly, given their involvement with the mortgage market factoring in those firm's relative size. But how bad is it? Ignoring the commercial paper market for the moment, are things really much worse in the corporate bond market? If you look at spreads, credits are much wider. In this environment, it is more valuable to look at absolute yields rather than relative spreads. Why is this? The US Treasury market is in the throes of what looks like a classic short squeeze. Despite the massive and increasing supply, investors spurning risk have no other options in this market than to buy Treasuries (Remember, investors are avoiding money funds, CP, etc.). Look at the absolute yield on selected financials. Five- and Ten-year Treasuries are roughly 75bps lower than three months ago. However, the absolute yield on Goldman, Citi, and many other top financials are basically the same. Weaker or perceived weaker credits, like the ones mentioned earlier, are at a higher absolute yield, and rightfully so given the increased credit risk. Spreads are wider, but much of it is due to a Treasury rally. The final point to mention is that all of this occurred at a time when credit spreads were ridiculously tight. They still are in certain sectors; look at Colombia and most of the rest of EM. Remember the pendulum, swinging from one extreme to another before finding equilibrium.