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    Boston, Mass.

    Default Climbing the Cliff of Doom-in dollars

    Climbing the Cliff of Doom-in dollars
    April 25, 2007 (iTulip)

    Forget "climbing a wall of worry." Today we are reminded to remind readers, Why are we Nervous? Because We Can't Do Without:

    Without cheap imports, CPI inflation will go through the roof
    Without continued loose and low rate lending, housing prices will continue to fall
    Without continually increasing deficit spending to generate new government jobs
    Without an ever increasing rate of new debt creation, key segments of the U.S. economy–especially consumption and finance–will contract.
    Without ever more rapid public and private sector debt growth, current GDP growth cannot be maintained
    o Without an ever more rapidly expanding money supply, the U.S. economy is ripe for a debt deflation, either via a near hyper-inflation or debt defaults
    Without the continued political support of foreign governments expressed as lending, we can't run our government, pay our existing debts, or our pensions or mortgages, or make payments on the last few hundred billion of leveraged buyouts

    It is from this final point that launch into today's AntiSpin, as it explains both the recent US market froth and the likely source of its demise.
    Lenders–Buyout Busters? (subsciption)
    April 23, 2007 (Edward Chancellor and Robert Cyran - Wall Street Journal)

    LBO Binge Could Wane If Huge Borrowing Need Exceeds Market's Supply

    Around $200 billion of leveraged buyouts were announced in the first quarter of this year, of which more than half occurred in the U.S., according to Dealogic. For the past couple of years, LBO activity has been doubling annually. Given the amount of money that has been raised by private-equity firms, this could continue for a while. Barclays Capital estimates that buyout shops have about $160 billion to spend in the U.S. alone. That could translate into $750 billion of deals this year.

    In the first quarter, buyout firms called the shots when arranging loans for their acquisitions. They borrowed cheaply using aggressive structures, such as payment-in-kind notes, and offered lenders little protection. But that could change. Private-equity firms may need as much as $600 billion in debt this year. Barclays estimates that lenders in the high-yield bond and institutional-loan market aren't likely to come up with much more than half this sum.

    Something like that happened toward the end of the technology-stock bubble in 2000, when the borrowing demands from big-spending telecom firms swamped the markets. There is another uncanny parallel with that period. After a brief period of thriftiness, corporations are once again bleeding cash. As in 2000, U.S. firms now run a financial deficit equivalent to more than 4% of gross domestic product. The earlier deficit was a prelude to the 2001 corporate-credit crunch.

    So far, the loan market has expanded to meet private equity's demands. But the ultimate suppliers of these loans, including the booming hedge-fund industry, don't have bottomless pockets. The hypergrowth in the buyout world is set to test their resources.
    The source of loans fueling the LBO bubble? According to Jim Finkel, CEO Dynamic Credit (iTulip Select Interview), between 45% and 60%–no one knows for sure–of the loans supporting LBOs is generated by the CDO market, the same securitization machine that generated enough loans to meet the demands of the housing bubble–until it didn't. Jim believes that the financial and economic risks posed by the LBO market are much higher than for the mortgage market. A crash of the LBO bubble will leave many very large companies unable to service debts without reducing costs. The largest expense of any corporation is payroll. Cost cutting will mean increased unemployment, which will feed into the declining housing market.

    The Chancellor/Cyran Wall Street Journal article continues:
    Coming IPO Boom

    Private equity isn't just testing the limits of the loan market. The stock market also is on a roll. Underwriters of U.S. stocks have just come off their two best quarters since the start of the decade. In the past six months, 161 companies raised close to $32 billion–about 60% more than was raised a year earlier. Like everything else on Wall Street, the leveraged-buyout business is driving this bonanza. LBO-backed stocks accounted for about a third of all initial public offerings in the past six months. Unfortunately for those concerned about innovation and the strength of the underlying economy, there has been a paucity of venture-capital-backed companies debuting on the public markets.

    Indeed, a bit less than $4 billion, or 12% of the amount raised in the past two quarters, went to these up-and-comers. This isn't impressive. It is just half of what these companies raised 10 years ago, let alone the massive floats seen during the dot-com era. Rather, the latest IPO surge is due to companies returning to the public markets after going private. This may not make investors happy -- shares in these companies tend to be priced higher and haven't performed as well as typical IPOs.

    But it will please bankers. Nine of the world's 10 largest LBOs occurred in the past 18 months. Already there is talk that some of these companies are winging their way back to the public markets, including high-end retailer Neiman Marcus. At some point nearly all of the record LBOs from today's astonishing buyout binge will try to return to the investors who sold them off in the first place. That will be the ultimate test of demand.
    So, today's headline is...
    Dow Closes Above 13,000 on Earnings Data
    April 25, 2007 (Madlen Read and Tim Paradis - AP)

    Dow Ends Above 13,000 As Earnings Reports Push Stock Market to Historic Heights

    It looks like cause for celebration: The Dow Jones industrial average surged from 12,000 to 13,000 in just six months. But appearances can be deceiving, and there may be more reason to worry than rejoice about Wall Street's latest accomplishment.
    ...and the news is, from the perspective of a DOW investor based, say, in Spain who owns the DOW in euros:

    That said, if you are in Spain–or the UK or Ireland–you are not fretting about your sideways crawling US stock market investments. You have other worries.
    Euro helps topple Spanish property
    April 25, 2007 (Ambrose Evans-Pritchard - Telegraph)

    Fears of a property crash swept the Spanish stock market yesterday, sending shares of construction companies into free-fall, and hitting banks exposed to the mortgage market. Spain's biggest property group, Sacyr, fell 8.15pc, while developers Colonial and Inmocaral plunged over 11pc.

    The current account deficit has reached 9.5pc of GDP, a sign of extreme over-heating. Spain is now the second biggest net contributor to global demand after the US, far outstripping China, astonishing for a country of only 40 million still living in the shadows of the Franco regime a generation ago.

    More than 800,000 homes were built last year, beating France, Germany, and Italy combined, leaving a glut of property hanging over the market. House prices have risen 270pc over the past decade to an average price of €276,000, but began to slow sharply late last year. Household debt has risen to 133pc of disposable income from 75pc in 1995.
    And you thought the US had a trade deficit and property bubble. How about the UK?
    Interest rates 'could reach 7.5pc'
    April 25, 2007 (Ambrose Evans-Pritchard - Telegraph)

    A group of Britain's leading monetarists have launched a harsh attack on the Bank of England's Monetary Policy Committee, warning that inflation risks surging out of control in repeat of earlier boom-bust cycles.
    Our final note echoes the sentiments expressed by Jim Rogers in a recent iTulip interview:
    Russian boom 'will end in pain'
    April 24, 2007 (Euro Today)

    Russia's financial boom will come to a painful end "in the near future", a leading London banker with long experience of the country warned on Monday.

    After seven years of growth, Russia was reaching its capacity limits in an expansion fuelled by credit, much of it from foreign markets, said Hans-Joerg Rudloff, chairman of Barclays Capital, the investment banking arm of Barclays.
    If a financial markets and economic correction happens all at once–US, European, China–and thus Asia–where does that leave the concept of "flight capital"? Out of which pan and into which fire?
    Last edited by FRED; 07-16-07 at 09:35 AM.



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