Credit Markets Get Even Scarier

John Jansen is scaring me today. Remember the new CDX investment-grade index, IG 11, which just launched? They took the crap out of IG 10 (Fannie Mae, Freddie Mac, WaMu), and put in solid corporates like Xerox and UPS. And yesterday IG 11 opened at 176.5bp: obviously no one wants any kind of credit right now, but those spreads you can live with, if you're not too levered.

This morning, by contrast, the IG 11 was trading in the 230bp range. And the new 10-year bond from IBM, which has a market capitalization of $118 billion and total debt of less than $35 billion, is trading at 400bp over Treasuries. That's over the 10-year Treasury, remember, which yields 3.85%; it's not over some T-bill yielding zero.

I don't think credit markets have ever been as frozen-up as this. As a consequence, the market is taking a we'll-believe-it-when-we-see-it approach to any talk of massive coordinated government intervention. Will the G7 governments follow the UK's lead and simply guarantee all bank liabilities? It looks likely, in which case Morgan Stanley bonds are a screaming buy at these levels. Remember that Morgan Stanley is a bank, now -- a bank whose CDS is trading at 28% upfront and whose spreads have hit 1500bp over an already-elevated Libor, but a bank all the same.

But there's the rub: if the government starts guaranteeing everything, then it moves one step closer to guaranteeing nothing -- as Iceland has found out. Here's Jansen:

If we are bursting bubbles, the Treasury bubble is the ultimate bubble.

There's no such thing as pure money: the dollar bill in your wallet is no more than a zero-coupon Treasury obligation. At the moment, Treasuries are still considered risk-free (although I haven't looked recently at the cost of protecting US sovereign debt, I'm sure it's elevated.) Maybe if Treasury takes on so much in the way of obligations that people start worrying about its own creditworthiness, they'll be able to put things like IBM bonds into perspective. And that might bring spreads over the risk-free rate down a little. Or, of course, it might not.

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