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Bonds Are a 'Safe' Investment: A Big Lie Gets Even BiggerYou may think the subprime mortgage mess is huge. Well just around the corner a larger elephant is looming and its impact may be even more devastating than the current credit crisis.
While it sounded like good news when banks sold $30 billion of loans for leveraged buyouts last week -- $26.4 billion of that was for the First Data buyout. That sale came with a big price tag -- banks agreed to sell the debt at 96 cents on the dollar, which means they locked in losses after their fees.
And then there was the problem of what to do with the other 90% of LBO loans in the pipeline.
The Wall Street Journal (subscription required) reported today that Citigroup Inc. (NYSE: C), Credit Suisse Group and J.P. Morgan Chase & Co. (NYSE: JPM) hold $400 billion in debt they promised for financing purchases private equity firms have in the works globally. If they can't sell the debt, they're left holding the bag, which means a lot less money for other loans. If the economy slows as expected and corporate profits weaken, the only way the banks will be able to unload the debt they're holding will be a fire sale on that debt at even deeper discounts then the First Data deal.
According to the WSJ article, hedge funds, which usually buy a lot of LBO, debt sat out the First Data sale because they expect to be able to pick up the debt even cheaper in the future. Just like when you want to buy a house, if prices are dropping, you sit on the sidelines and let the market fall to get the best bargain. Someone caught up with a house that won't sell may end up in foreclosure. While the banks aren't anywhere near foreclosure, if they are forced to take deeper and deeper discounts to get rid of the debt, what will happen to their bottom line and the investors who hold their stocks?
Lita Epstein is the author of more than 20 books including "Trading for Dummies" and "Reading Financial Reports for Dummies."
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