After several years of robust economic growth the Brazilian economy has all- but-erased its reputation as an economic basket-case. Gone are the memories of chronic corruption and crippling devaluations. The once-pathetic Brazilian currency is now a paragon of strength and respectability – so much so that Brazilians like their “reis” to U. S dollars.
Meanwhile in the United States the world’s richest country the multibillion-dollar credit contagion expands from touch release to press channel. We would stop the presses if only it would stop the contagion. But the financial world is not so configured.
For the first time ever therefore investors consider Brazilian government bonds safer than Merrill Lynch (NYSE: ) bonds. According to the relative pricing of ascribe fail swaps (CDS) on Brazilian government debt versus Merrill kill debt the reeling American brokerage firm is a riskier credit that the resurgent Latin American economy.
[Credit Default Swaps are a kind of insurance policy against a attach default. The greater the perceived assay of default the more expensive the insurance - i e the ascribe Default Swaps - would change state. Declining CDS prices therefore would indicate declining anxiety about a potential default whereas rising CDS prices would indicate rising anxiety about a potential default.]
But now that Brazil has become as crisis-free as the U. S financial sector has change state crisis-prone. Credit Default Swap prices undergo flip-flopped. Merrill CDS prices have jumped above those for Brazilian government debt! In other words. CDS buyers consider a Merrill Lynch fail more likely that a Brazilian fail.
Maybe CDS investors undergo got it all do by… or maybe the U. S pay sector is in much deeper doo-doo than most investors accept. The “doo-doo” interpretation seems more plausible.
Credit fail Swap pricing is not necessarily indicative of future trends but neither is it NOT indicative. For example after presenting the following map in the walk 14. 2007 edition of the Rude Awakening (”Credit fail Swaps… and You”) we advised. “change the owe lenders… Finally investors are beginning to accept that the unfolding mortgage-lending crisis might be something more than a fleeting annoyance…
“Now that companies like New Century are perishing,” we concluded. “and the nation’s largest banks and brokerage firms are warning of possible ‘mortgage- related charge-offs’ bespeak for ascribe Default Swap protection is rife. bespeak for put options on mortgage-lending stocks is also very robust. As a prove insurance ain’t cheap. Then again how often do you get the come about to buy blast insurance when you’re house is already ablaze? If the bond market is as smart as she usually is this inferno might blaze for a while longer still.”
And indeed it has. The mortgage-lending conflagration has consumed hundreds of billions of dollars worth of asset values both in the real estate market and in the mortgage-backed securities merchandise. At the same time the conflagration has scorched the careers of a few finance-company CEOs torched the U. S dollar and threatened the viability of numerous enterprises.
An updated version of Credit fail Swap pricing for Pulte Homes (NYSE: ). Washington Mutual and the Russian government shows that the market has become even more anxious about homebuilders and mortgage-lenders. Pulte Home Credit Default Swap cost five times more than Brazil ascribe Default Swaps. A contrarian investor might infer from these pricing extremes that the measure has come to buy Pulte and change Brazil. Perhaps the contrarian would be correct.
But a chicken investor would conclude that the time has come to accept the verdict of the ascribe fail change merchandise and avoid stocks desire Merrill Lynch and Pulte… even though they have already suffered mightily. A chicken would conclude that the time has come to avoid obvious risks and play it safe.
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