Bond Outlook April 25th

Our bias against structured and securitised bond products is based on their two major lacunae: liquidity and transparency. Both are hurting bond investors seduced by the extra yield offered by mortgage-backed bonds in the USA, especially those “supported” by sub-prime lending. The more sophisticated buyers have been boasting that they have taken only the AAA portion of the CDOs, but someone must have been buying the low-credit portion!

At last some estimates of the size of the problem have been published, thanks to Pacific Investment Management Co.:

• There are more than USD 6 trillion of mortgage-backed bonds outstanding (about half as much again as the US Government debt)
• Some USD 450 billion of these are linked to sub-prime
• The prices of these have already dropped by a total of USD 75 billion to date.

Some of the losses are being borne by banks such as HSBC, which was the first to announce its losses. We expected other banks to follow suit, but little has come to light about or from them.