One Bank’s Warning As Credit Cracks: ‘The Black Swan Is A Liquidity Crisis’

One Bank’s Warning As Credit Cracks: ‘The Black Swan Is A Liquidity Crisis’

"[We have] reviewed [our] pandemic planning procedures and are prepared to respond appropriately if and when the situation progresses", the Cboe said Friday, adding that, if necessary, it will close the Chicago pits and operate the options exchange in “electronic only trading mode". “Cboe is prepared to facilitate the normal operation of all trading platforms by staff working from remote locations, including from home, if warranted”, a statement reads. It was the latest sign that financi
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5 thoughts on “One Bank’s Warning As Credit Cracks: ‘The Black Swan Is A Liquidity Crisis’

  1. During the Rosh Hashannah week, it is said that on Rosh Hashanna (new year) the fate of the next year is written, by Yom Kippur it is sealed. The flattening yield curve was the new year- widening credit spreads wtih an exogenous shock to the economy (virus) seal your fate. As sure as day follows night we are in for an economic slowdown. If not properly dealt with it will be a major long lasting one. I am not reassured so far by either the Trump Administration or the FOMC.

    For a very long time I have watched and waited for bank loan mutual funds and ETFs to blow up. I thought it was almost a given. Why? My understanding is that bank loans are a bit illiquid and take 2-4 weeks to settle once traded. That is in a regular normally functioning market. I was stunned when I saw Jeff Gundlach recommend them on a Barron’s panel a year or two ago. The only way I would touch this asset in a pooled vehicle that would either be in a closed end fund or interval fund structure- where there was a decent liquidity match for the asset. I am actually not as concerned about high yield ETFs because the ETF structure by definition forces the ETF to buy the bigger deals which have more liquidity- in fact the structure forces the manager to be more cautious and conservative; and the ETF structure also allows a couple of routes to tap liquidity. I would avoid mutual funds for high yield on the other hand- Third Avenue fund was a prima facie case and it has already happened. Liquidity if not addressed often migrates to solvency or credit issues. Although I am cautious about municipal bond high yield ETFs, if you drill down and look at them, they have a sleeve of investment grade investments. I do not think their risk of a blow up is excessive. And for the same reason as taxable high yield ETFs their structure forces the manager to focus on the larger issues which is a plus. Not so sure about high yield municipal bond mutual funds.

    I am a professional investor with long years in the bond market and have studied these issues for some time. I could be wrong of course but I have a solid basis for making these comments. Caveat Emptor.

    1. Appreciate the thoughtful comment. What you’re describing is analogous (to my ears) to CDOs (or CDOs squared) where the risk of the underling asset is mitigated by bundling it into a larger structure of similarly risky assets, Genius.

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