 An unprecedented wave of volatility swept through credit markets in the September quarter, impacting liquidity and spreads and jolting some of the world’s biggest financial institutions. Jonathan Shapiro reports.
For many in credit markets, the third quarter of 2007 was one of the harshest and most challenging of their careers. “Clearly this was one of the most volatile quarters for credit since 2002. It was a timely reminder that volatility is a feature of credit. With spreads having compressed over the last five years, they were increasingly skewed towards a move wider,” said Andrew Canobi, investment manager, credit for INVESCO’s fixed income team.
The credit crisis began with hedge fund implosions and continued with a liquidity crunch and central bank intervention. The fuse was lit by the collapse of the sub-prime home lending market in the United States.
As the market grappled with the extent of losses in the sub-prime sector, US banks and finance companies felt the pain of rising delinquencies and falling house prices. When Bear Sterns reported that two of its hedge funds would be liquidated as a result of losses incurred through sub-prime exposure, the effects of the housing crisis on financial markets became apparent. And when the largest mortgage lender in the US, Countrywide Financial, drew on its credit lines to avoid bankruptcy, sheer panic set in.
The crisis quickly spread into credit markets. Liquidity and deal flow dried up in the US Asset Backed Commercial Paper (ABCP) and term markets. Investors looked to exit the ABCP market and called for repayments, forcing conduits to sell assets or draw on liquidity lines, and pushing spreads drastically wider.
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