Credit is Front and Center Again/Still

Top Line: The stock market hit a speed bump on Wednesday morning when UBS announced earnings that were dragged down by, what else, mortgage problems. But, there was something in the report that suggested that subprime was not the only source of their problems. The stock market reaction to the news was to sell now and ask questions later.

There have been a few news items the Update has missed this week. A notable one is the one about the municipal bond offering that was held without very many buyers causing the rate to jump to 20%. This was a modest $100 million offering that couldn't be sold without raising the rate to an unusually high rate. In the Treasury bond market we have talked about the bid to cover ratio and how important that is. In this case, the same concept applies.

Bid to cover means how many bids were there to cover the auction. An entity says they have $100 million of bonds to sell and would like bidders. If there are enough noncompetitive bids the auction goes off without any trouble at the rate specified in the offering. Competitive bids may come in at higher interest rates, or more to the point, lower prices in order to get higher rates.

So, in the case where noncompetitive bids are inadequate to cover the auction, they offering would have to go out on the Tail to fill its needs. The tail is where competitive bids reside and determine the final interest rate on the bond offering. The rate of interest is the same to all bidders so the more bidders there are, it would seem, the lower the interest rate.

In the case where there are a lot of bids, the bid to cover ratio is high and there is plenty of flexibility to issue the bond. On the other hand, if there are few bids compared to the offering, then you have what happened on this particular offering--not enough buyers to cover the offering and the bond goes out at 20%. Yicks.

In the bigger picture this is all part of the "credit crisis" which we have heard so much about over the past several months. On Thursday, the Chairman of the Fed said to the Senate Banking committee that he was prepared to lower rates again in order to maintain growth, albeit slower growth. He even said that with the government rebate program along with the Fed's rate reductions, the economy would start moving forward again in the fall. Where have we heard this before???

Seriously, we have looked at the headlines in the WSJ for days and weeks now and have seen that credit has been the central theme in what seems like half of the articles. We just can't keep up on reporting them all. We hope that you have been prepared to read these articles with some "insider" knowledge of how some of these things work.

One last item is that the options expiration is Friday (today for you) so there could be a little more volatility. The significance of options expiration is not necessarily very important, it just serves as another opportunity for the market to struggle.

The market is in a dangerous place right now. Many are hoping for the best with all of the attention being thrown at the mortgage problem and the rebate program. The problem is that the stock market is not much better off after all of the attempts of the Fed and the Government to stop the bleeding. We think there is ample room for the market to drop hard due to the dashing of hope that will come from no buying.

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