Richard Russell Comments, page-9

Wednesday’s Heard on the Street column in the Wall Street Journal discussed the recent trading in Ford bonds. The article mentioned that some dealers were starting to price the paper in dollars and cents, not as a spread above Treasuries, which investment grade bonds are usually priced. Spreads have widened dramatically over the past week and it continued on Wednesday. Today as Treasuries lost 6.6 basis points, the yield on Ford 10-year bonds jumped 30 basis points. This 36 basis point widening over treasuries caps off an historic week that so far has seen the spread to treasuries widen 111 basis points in the last four trading days to 580 basis points over Treasuries. For a little prospective, Ford bonds traded around 200 basis points above Treasuries over the past 18-months before starting a complete decoupling this summer. General Motors’ bonds have widened a similar 109.9 basis points since Thursday, with 42.5 basis points just today. It is not confined just to the automakers, Household’s spreads have also widened dramatically. Its bonds widened 44.5 basis points today and 103.2 basis points since Thursday.

Looking at the spread historically it is amazing how wide they moved considering how low government bonds are yielding. Last year, Ford paper traded 200 basis points above Treasuries when Treasuries yielded 5%, making the spread about 40% of the Treasury. Now Treasuries yields are at 3.5%, so the 9.4% yield Ford traded at today is 270% above the Treasury. This does not make for a good trade if you shorted Treasuries to buy Ford paper. If a hedge fund put this trade on in mid-July when the spread was 250 basis points, which was the high side of a one-year trading range (200 to 250 basis points), the fund would have expected a standard deviation of 35 basis points. In the past four days it would have seen a three standard deviation move. For more prospective, during the Russian collapse in 1998. Ford bonds widened 47.7 basis points over a one-week span. As you might remember the Russian default set in motion the wheels to send LTCM over the edge. During this whole financial meltdown, Ford bonds widened from about 120 basis points over Treasuries to about 220 basis points, 100 basis point of widening. I’ll repeat, Ford’s bonds have widened 111 basis points in the last four trading days.

There is definitely something brewing in the credit markets. We also think the same stress is in the asset backed securities (ABS) market. All three of the above companies are also involved in the ABS market. If the ABS market is undergoing the same stress as the lower grade corporate bond market is displaying, it will not be long until the easy financing that consumers have grown accustomed to is withdrawn.

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