Bond Outlook July 18th

Last week we stated that the problems of mortgage-backed CDOs reflected a systemic failure of the US financial system. Our own activity in the fixed-income markets is providing further support for this statement, notably in the difficulty of finding market prices for structured products of many types (see “Focus” below). Moreover, the announcement by the Fed, just before Bernanke goes before Congress, that they and state regulators are to run a pilot scheme to monitor mortgage lending is a tacit admission that regulation has been inadequate.

In our Weekly we have always expressed the strongest reserves about structured products (which include CDOs), mainly on the grounds of insufficient liquidity for holders wishing to sell these securities. The lead managers, i.e. the issuers of structured products, are supposed to have a responsibility to be market makers in the issues they sponsor. Yet they have consistently failed to develop and maintain secondary markets. All they are interested in are the juicy fat front-end commissions. The anecdotal evidence within our business is that, over the past fortnight, we have been unsuccessfully seeking a market price to sell a mortgage-backed CDO The lead manager, a major US Investment Bank, has played every trick to avoid answering us (person in charge on holiday, his deputy at a meeting, the need to go before a committee, etc.).