bad and getting worse

Here's another article on the subprime rot spreading up the credit chain. Credit is still tightening. Bloomberg reports that "Cambridge Place Investment Management LLP said today it will close the $908 million Caliber Global Investment Ltd. fund after losses on U.S. subprime debt," and "At least eight companies abandoned bond sales this week."

We're entering a period where these funds could fold on a daily basis, as any loss at all will cause a margin call. Remember, the beauty of CDO's is that you can put almost any price on them. However, when someone else lends you money, THEY get to put any price they want on them.

In other words, institutional lenders to hedge funds can pretty much help themselves to any hedge fund assets they want to, simply by raising margin on subprime-backed CDO's.

I think this is a possibility that could prove too much temptation for someone to pass up. Merrill Lynch bears watching closely, since they have inside knowledge of the Bear Stearns assets and what they're worth. They are also one of the largest institutional lenders to hedge funds.

In the meantime, until credit tightening catches us with foreign central banks, fewer choices for them should create greater demand for Treasuries, probably the ones with higher yields. We could see the yield curve flatten out again in the next few months. We will almost certainly see credit spreads widen.

I think cash is the best place to be right now. Any market rallies will be self defeating; the higher they go, the greater are the chances of killing the private equity buyouts.

As far as the Fed goes, Bernanke will announce, "Given our expectations for GDP growth to rebound in the second quarter, our stance on interest rates remains unchanged. The housing market is slightly weaker than expected, but that weakness remains contained. Housing weakness and rebounding growth should continue to temper inflation expectations caused by full employment and capacity utilization."

The market will take off for a couple of days until Bernanke decides to throw some cold water on it.