Has Bear Stearns finally popped the great world bubble?


Richard Moore

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Has Bear Stearns finally popped the great world bubble?
Posted by Ambrose Evans-Pritchard on 04 Jul 2007  at 12:06

Is this the 'Big One'? Is the Bear Stearns blow-up the moment when America¹s 
subprime debacle spills over into the global credit markets and pops the 
greatest bubble of all time?

Or have China, India, and Russia changed the game? Has their inclusion in the 
traded world economy - the ³great doubling² of the global consumer base, in the 
words of Professor Richard Freeman ­ stretched the economic cycle by an extra 
couple of years?

Well, the coal-face analysts I talk to at Morgan Stanley, Goldman Sachs, 
Deutsche Bank, Barclays Capital, et al, all think there is enough liquidity to 
keep the global boom going well into 2008 - with Europe, Japan, and the emerging
BRICs doing the heavy lifting as America takes a breather.

Most expect a nasty squall now, or soon, one that will knock another 7-8pc off 
stock markets, perhaps pushing America¹s S&P500 down a hundred points to its 
200-day moving average - currently at around 1432.

Every bull market needs mini-purges on the way. Technically, Wall Street and the
Euro-bourses look wicked, with double tops and momentum indicators tipping into 
the graveyard (RSI, ROC, Stochastics, and MACD).

So no, the 'pros' are not yet calling the big one. But then they never do, until
it happens. Such is the curse of consensus, and slavery to linear economic 
models. Crashes are famously non-linear.

We have clues. Alchemy¹s boss Jon Moulton told the House of Commons this week 
that the private equity boom was ³somewhere near its top.² Anthony Bolton, 
Britain¹s Warren Buffet, told a forum in Monaco that the vast CDO and CLO debt 
boom was based on false models and could ³collapse².

We learn that investors in the Bear Stearns Enhanced Leveraged Fund are getting 
offers of just 5 cent on the dollar for their stakes. A wipe-out, in other 

The Bear Stearns rot goes much deeper of course. When Merrill Lynch forced a 
fire-sale of assets, it revealed that even A-grade tranches of these CDO 
mortgage debt securities were worth just 85pc of face value, and the B-grades 
nearer zilch.

The creditors orchestrated a quick cover up, but the CDO cat is already out of 
bag. We now know that some $2 trillion of subprime and 'Alt A'  mortgage debt is
falsely priced on the books of banks and funds worldwide. Worse is surely to 
come. Bank of America warns that $500bn of adjustable mortgage debt in the US 
will be reset upwards in the second half of this year by an average 2 percentage
points, and a further $700bn next year.

For now, bears are all watching the yield on that 10-year US Treasury bond ­ the
benchmark price of world money, the Christmas Tree upon which all the other 
baubles hang: property booms, the emerging market bubbles, leveraged buy-outs, 
hedge funds and private equity, those $410 trillion in derivatives contracts 
(seven times global GDP) and that $2.5 trillion of debt packaged as ³structured 

The yield surged 65 basis points from early May to mid June to nearly 5.25pc on 
inflation scares, the fastest rise since 1994. Interestingly, the 94 bond shock 
did not in itself cause a US recession. But then the US was a very different 
country. There was no housing bubble, for starters.

However, it did set off the chain of events that led to Mexico¹s Tequila crisis 
and the China bust a year later. Notice the time delay. My guess is that the 
latest credit crunch will set off a slow-fuse crisis in Eastern Europe, now the 
epicentre of speculative excess. Watch Hungary and Latvia, both current account 
disaster cases.

For now, the 10-year yield has since slipped back to 5.04pc. Don¹t be fooled. 
Part of that is a fear reaction as spreads widened between quality and junk. 
There most certainly is a credit crunch at the low end ­ or a ³gale force wind² 
in the words of SocGen¹s debt guru, Suki Mann.

Just $3bn of the $20bn junk bonds planned for issue last week were actually 
sold. A long list of leverage buy-outs and dodgy floats have been pulled, or 
cancelled. Alliance Boots will have to pay 35 basis points more for the £9bn of 
debt required for its own jumbo buy-out by KKR.

(Strange, is it not, that victims of these bandit raids should have to pay for 
their own funeral pyres. Why is KKR not be raising its own debt, on its own 
books, or have we all lost sight of the greater morality here?.. But I digress.)

Roughly $300bn of leveraged buy-outs waiting in the pipeline will face a frosty 
reception, and perhaps a volley of rotten eggs. Without the takeover spree to 
juice the stock markets, the indexes will falter and then fall back.

Never take my rotten advice on the markets, but it might be good time to cash in
a few stock gains, and rotate a little wealth into banal interest-bearing 
accounts. The cycle is already one year beyond its normal life. The balance of 
risk and reward it turning ever less friendly.

Posted by Ambrose Evans-Pritchard on 04 Jul 2007 at 12:06

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