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The Spillover and Why It Isn't Helping the Battered US Economy (February 13, 2008)

Location: New York
Author: Lenny Broytman
Date: Wednesday, February 13, 2008

Not only is the crippled credit market refusing to loosen its grip on the US economy, it is getting worse. Since the summer, many of the major investment banks in the US have lost billions in mortgage-related securities but now, it appears as if the problem has spilled over into other credit sectors.

In a vital development that's essentially been months in the making, the Wall Street Journal reports that many of the largest banks on the planet are fearing the worst. As a result of a US credit market that is only worsening as time goes on, many expect the US banks to ease back on the amount of money they are willing to lend to consumers and small businesses alike. In a nation currently riddled with fears of a recession, the aforementioned can only bring harm and bring one about even faster.

According to the Journal, Standard & Poor's said that their index of the prices on high-risk corporate loans fell to a record low of 86.28 cents on the dollar by week's end.

The simple fact that the Federal Reserve has cut interest rate s at such a frantic pace has also had some unintentionally negative effects; with interest rates falling, many investors are being scared rather easily by poor-performing stocks that are affected by the cuts.

"You've had the biggest credit bubble -- probably the biggest credit bubble we have ever had," says Jim Reid, credit strategist at Deutsche Bank AG in London . According to Reid, a huge chunk of the bubble has already been unwound. The problem is, "nobody quite knows where that ends."

The Journal reports that one of the areas of the market that is being hit the hardest are US firms with extremely low credit ratings. Some of the problems in the sector reportedly began earlier this summer, when many investors began to stay away from buyout loans out of sheer fear.

Following a number of highly-publicized announcements highlighting the rating agencies' acceptance of a need for change, Fitch Ratings said that they were slicing the credit ratings on pieces of 24 CLOs, sliding many of them into junk territory, with either triple-C or double-C ratings.

And that isn't all; the Journal says that virtually all areas of the US credit market are in jeopardy. As the Journal writes: "Problems are cropping up elsewhere in credit markets. Money-market investors in the past have been large buyers of short-term instruments backed by tax-free municipal bonds and student loans. But they have been shunning these instruments -- known by such names as auction-rate securities and tender-option bonds -- because they fear the debt used to back the instruments will default or get downgraded by rating services."

All in all, the credit market is going to get a lot worse before it gets better. And once again, a lot of it goes back to the consumer. When people flip on CNBC and see stories about investment bank A writing off $1 billion or investment bank B having its share price drop 20 percent, it all goes back to the average Joe simply being unable to pay his bills. With today's housing market spiraling virtually out of control, it seems as if the spillover is almost inevitable. And with the latest auto debt and credit card debt numbers in the US, it appears that the aforementioned has already begun.

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