Waiting for Godot … Life in a cargo cult

If you are a distressed investor or restructuring professional, the last few years of waiting for default rates to begin creeping up so that you can start paying the rent have been akin to praying for WWII US supply planes to resume dropping shipments of Military supplies onto the coral sands. Of course, the planes never returned after the close of hostilities. Nevertheless cargo cults persisted until well into the sixties in the South Pacific. So much for perseverance.

Fortunately, the last several weeks of market activity have provided enough evidence to conclude that the credit cycle has not been repealed. The sub-prime crisis – itself the offspring of the Fed-engineered liquidity bubble – has blossomed into a worrying portent of what the future might hold for the credit markets. Key market players have been badly mauled – loss estimates on the Street alone run well over $100 billion; the list of transactions that have become non-bankable has exploded – leading to fears of a 25-50% decline in investment banking business over the remainder of the year; over $200 billion of buyout deals are said to be weighing on investment banks’ balance sheets; and the financial battlefield is being littered with the carcasses of lenders brave (or desperate) enough to have lent to highly risky borrowers, along with their investors and leveraged hedge fund players.

To underscore the “new” Global nature of the markets, the pain of the US sub-prime crisis has been felt as far afield as Australia, South East Asia, the UK and South America. At this moment earnest risk managers in financial businesses are poring over their credit reports intending to reduce exposure to shaky borrowers and high volatility business lines.

Will their actions be enough to contain the spreading malaise or will stronger (central bank) medicine be needed to further forestall the ultimate day of reckoning? Stay tuned.

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