John Hussman: Renewed Concern About Credit Default Spreads

Excerpt from the Hussman Funds' Weekly Market Comment (1/12/09):

On the hopeful side, the market appears generally oversold, and is near what could be considered reasonable support. Given the loss of favorable market action, we wouldn't invest on the expectation that this support will necessarily hold, but as noted above, about half the Fund's exposure is hedged with option combinations that amount to in-the-money put coverage. So a recovery in the market will put us in a more constructive position somewhat automatically, without having to rely on that outcome.

Another hopeful aspect to current conditions is the possibility of some significant policy announcement regarding financials as the Obama administration begins. From my perspective, the factor of immediate concern is again the capital cushion on the liability side of bank balance sheets. As banks experience losses on the asset side of their balance sheets, the same amount has to be subtracted from the liability side, and that amount comes out of “shareholder equity,” more commonly known as “capital.” Failing new capital injections, and quickly, could rapidly produce conditions similar to what we observed in October and November. That is what the rapid spike in credit default spreads is telling us here.

Second to fresh capital injections from TARP funds, the new Obama administration will need to directly address foreclosure abatement. Government policy is strongest and most appropriate in areas where there is a “coordination failure” that the private markets simply cannot address, and dealing with distressed mortgages is a prime example.

...

Unfortunately, the fresh deterioration in market action and credit default spreads suggests that the need for intervention is becoming urgent. Again, there is a possibility that the new Obama administration will address some of these issues fairly quickly – particularly in regard to immediate capital infusions to major money center banks. In that event, a recovery of more than a few percent in stock prices would put us in a position to moderately participate in market fluctuations. Here and now, however, our immediate response is to move with the evidence at hand, and we have done so by tightening our hedges against the risk of fresh deterioration in the market.

Comments

[Socialism c...:]

"...the market appears generally oversold..."

Do you care to provide a basis for that? I don't see any in the article. I happen to believe it is undersold. We will see Dow 5000 in H1.

"Second to fresh capital injections from TARP funds, the new Obama administration will need to directly address foreclosure abatement."

How do you reconcile this with the re-defaulting going on? We do NOT need to prevent foreclosures. Rather, we NEED to let them happen! Those who bought what they couldn't afford must give it up...or this economy will not rebound.

Jan 20 05:56 PM

[whidbey:]

The CDS spike is just part of the larger failure of liquidity. It is beyond government to cope with the massive losses in equity investments, or the depreciation of the balance sheets of the banks. Some where in here it must become clear that we need a new currency based on PM. No one trusts private or government credit or liquidity.

Yet to be dealt with are commercial real estate defaults, credit card back debt, student loans, and the fact that most of the mortgage renegotiation mortgages are limited to those who have 700 + FICO scores and some assets: the average mortgagee.

By the way what happened to your line in the sand at 850-900 ???

Jan 20 05:57 PM

[Crocodilian:]

Some where
> in here it must become clear that we need a new currency based on
> PM. No one trusts private or government credit or liquidity.

Then why are Treasury auctions massively oversubscribed (bid : fill ratios of 4 :1 or more) at historically low yields?

Clearly someone trusts government credit . . . in fact, is desperate for it.

Jan 20 07:23 PM

[bs_o_meter:]

For as long as i have been reading SA, you have been continuously spinning negative news to look positive. I challenge readers to review your past posts.

It reveals the only thing you care about is to have people invest (i assume with you) in the market. does not matter is they lose their a$$. are you able to sleep at night?

Jan 20 09:05 PM

[Mr MarkToMa...:]

It's Credit Default Swaps, not spreads...sheesh...goo... to know that "experts" write these seeking alpha articles...

Jan 20 09:34 PM

[Big K:]

Halt! There should not be anymore TARP funds for these banks until a full investigation and reporting to the country is made. Citizens should not pay another dime to bail out these idiots until we all understand what was done, by whom, and when. I'm tired of the taxpayers being asked to bail out these silly banks and we don't even have any investigation as the larcenous tomfoolery that occurred here. There needs to be some criminal investigations, and complete disclosure as to what happened and why. If not, let them burn!

Jan 20 09:46 PM

[PeakOiler:]

"It's Credit Default Swaps"

No it's not. It's credit default spreads, lower case. He is referring to the spreads on the CDSwaps, which are widening because risk appears to be increasing. He takes that as a warning of defaults to come.

Jan 20 09:50 PM