Capital Markets

Liquidity Crunch: How Long Will It Last?

Investors are divided over whether the current liquidity crunch represents a short-term event or a structural crisis, a Greenwich Associates study ...
Stephen TaubSeptember 21, 2007

Institutional investors have grown fed up with structured financial products and fixed-income products and are trying to cash out their current portfolios, a new study by Greenwich Associates concludes. The global credit crisis sparked by the collapse of the U.S. subprime mortgage sector has caused a nearly complete disruption in the trading and use of many fixed-income products, the study finds.

Greenwich consultant Tim Sangston characterizes this as “perhaps the clearest indication of the severity and extent of the liquidity disruption.” He adds: “It’s hardly an exaggeration to call this a total market breakdown.”

But investors who were surveyed are divided over whether the current liquidity crunch represents a short-term event or a structural crisis. According to the survey of 251 institutional investors, 55 percent see the liquidity crunch as a structural crisis, while 45 percent see it as a short-term event.

Keep in mind, however, that the survey in North America, Europe, and Asia took place before the Federal Reserve cut interest rates by half a point on Tuesday. Indeed, The Wall Street Journal noted that on Wednesday there were some encouraging signs of life in the debt markets as a result of the rate cut, as Lehman Brothers Holdings Inc. and General Electric Capital Corp. each sold about $3 billion in investment-grade bonds, while R.H. Donnelley Corp. sold $1 billion in junk bonds, much more than the $650 million it had earlier planned to sell.

Further, the regulator for Fannie Mae and Freddie Mac agreed to ease restrictions on the mortgage-finance companies’ investment holdings, which could add much-needed liquidity to the reeling mortgage market.

Perhaps underscoring the uncertainty highlighted by the survey, however, credit markets were back to their jittery state by Thursday. In any case, more than 80 percent of the survey participants active in asset-backed securities and collateralized debt obligations say they have experienced difficulty getting a price quote from their fixed-income dealers on these products since the market turmoil surfaced.

Nearly 80 percent of the collateralized loan obligation users and nearly 70 percent of the leveraged loan investors say they’ve had trouble getting a dealer quote on the products. And nearly 65 percent of survey participants active in mortgage-backed securities and more than 60 percent of commercial mortgage-backed securities investors report the same difficulty. Similarly, more than 60 percent of participants active in corporate bonds say they’ve experienced trouble getting a simple price quote from dealers on these usually liquid products.

The uncertainty in the markets has caused more than 45 percent of survey participants to say they’ve deliberately changed their portfolio’s credit profile as a result of market conditions, including more than half the institutions with more than $100 billion in assets under management.