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POSTS: Weekend, 01-29-2011
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TIPPING POINTS

Process of Abstraction

Research Process

1- Sovereign Debt Crisis
2- EU Banking Crisis
3- Bond Bubble
4- State & Local Government
5 - Risk Reversal
 
6 - Residential Real Estate -
Phase II
7 - Commercial Real Estate
8 - Central & Eastern Europe
9 - Chronic Unemployment
10 - US Banking Crisis II
11 - Pension - Entitlement Crisis
12 - North & South Korea
 
13 - Public Policy MIscues
14 - Rising Interest Pressures
15 - Food Price Pressures
16 - US Stock Market Valuations
17- Finance & Insurance Balance Sheet Write-Offs
18 - Japan Debt Deflation Spiral
19 -Credit Contraction II
 
20 - US Reserve Currency
21 - US Fiscal, Trade and Account ImBalances
22 - China Bubble
23- Government Backstop Insurance
24 - Corporate Bankruptcies
25 - Slowing Retail & Consumer Sales
26 - Public Sentiment & Confidence
27 - Shrinking Revenue Growth Rate
28 - US Dollar Weakness
29 -Global Output Gap
30 - Oil Price Pressures
31 -Natural Disaster
32 - Pandemic
33 - Iran Nuclear Threat
34 - Crisis Programs Expiration
35 - Terrorist Event

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TIPPING POINTS

"The moment of critical mass, the threshold, the boiling point"

The tipping point is the critical point in an evolving situation that leads to a new and irreversible development. The term is said to have originated in the field of epidemiology when an infectious disease reaches a point beyond any local ability to control it from spreading more widely. A tipping point is often considered to be a turning point. The term is now used in many fields. Journalists apply it to social phenomena, demographic data, and almost any change that is likely to lead to additional consequences. Marketers see it as a threshold that, once reached, will result in additional sales. In some usage, a tipping point is simply an addition or increment that in itself might not seem extraordinary but that unexpectedly is just the amount of additional change that will lead to a big effect. In the butterfly effect of chaos theory , for example, the small flap of the butterfly's wings that in time leads to unexpected and unpredictable results could be considered a tipping point. However, more often, the effects of reaching a tipping point are more immediately evident. A tipping point may simply occur because a critical mass has been reached.

The Tipping Point: How Little Things Can Make a Big Difference is a book by Malcolm Gladwell, first published by Little Brown in 2000. Gladwell defines a tipping point as "the moment of critical mass, the threshold, the boiling point." The book seeks to explain and describe the "mysterious" sociological changes that mark everyday life. As Gladwell states, "Ideas and products and messages and behaviors spread like viruses do."

The three rules of epidemics

Gladwell describes the "three rules of epidemics" (or the three "agents of change") in the tipping points of epidemics.

  • Connectors are the people who "link us up with the world ... people with a special gift for bringing the world together." They are "a handful of people with a truly extraordinary knack [... for] making friends and acquaintances". He characterizes these individuals as having social networks of over one hundred people. To illustrate, Gladwell cites the following examples: the midnight ride of Paul Revere, Milgram's experiments in the small world problem, the "Six Degrees of Kevin Bacon" trivia game, Dallas businessman Roger Horchow, and Chicagoan Lois Weisberg, a person who understands the concept of the weak tie. Gladwell attributes the social success of Connectors to "their ability to span many different worlds [... as] a function of something intrinsic to their personality, some combination of curiosity, self-confidence, sociability, and energy."
  • Mavens are "information specialists", or "people we rely upon to connect us with new information." They accumulate knowledge, especially about the marketplace, and know how to share it with others. Gladwell cites Mark Alpert as a prototypical Maven who is "almost pathologically helpful", further adding, "he can't help himself". In this vein, Alpert himself concedes, "A Maven is someone who wants to solve other people's problems, generally by solving his own". According to Gladwell, Mavens start "word-of-mouth epidemics" due to their knowledge, social skills, and ability to communicate. As Gladwell states, "Mavens are really information brokers, sharing and trading what they know".
  • Salesmen are "persuaders", charismatic people with powerful negotiation skills. They tend to have an indefinable trait that goes beyond what they say, which makes others want to agree with them. Gladwell's examples include California businessman Tom Gau and news anchor Peter Jennings, and he cites several studies about the persuasive implications of non-verbal cues, including a headphone nod study (conducted by Gary Wells of the University of Alberta and Richard Petty of the University of Missouri) and William Condon's cultural microrhythms study.

 

RESEARCH METHODOLOGY

 

PROCESS OF ABSTRACTION

 

 

SOVEREIGN DEBT & CREDIT CRISIS

 

Inverted chart of 30-year Treasury yields courtesy of Doug Short and Chris Kimble. As you can see, yields are at a "support" area that's held for 17 years.

If it breaks down (i.e., yields break out) watch out!

The state budget crisis will continue next year, and it could be worse than ever. That's part of what's freaking out muni investors, who last week dumped them like they haven't in ages.

States face a $112.3 billion gap for next year, according to the Center on Budget and Policy Priorities. If the shortfall grows during the year -- as it does in most years -- FY2012 will approach the record $191 billion gap of 2010. Remember, with each successive shortfall state budgets have become more bare.

Things could be especially bad if House Republicans push through a plan to cut off non-security discretionary funding for states, opening an additional $32 billion gap. 

MUNI BOND OUTFLOWS

RISK REVERSAL

 

RESIDENTIAL REAL ESTATE - PHASE II

 

COMMERCIAL REAL ESTATE

2011 will see the largest magnitude of US bank commercial real estate mortgage maturities on record.

2012 should be a top tick record setter for bank CRE maturities looking both backward and forward over the half decade ahead at least.

Will this be an issue for an industry that has been supporting reported earnings growth in part by reduced loan loss reserves over the recent past? In 2010, approximately $250 billion in commercial real estate mortgage maturities occurred. In the next three years we have four times that much paper coming due.

Will CRE woes, (published or unpublished) further restrain private sector credit creation ahead via the commercial banking conduit?

Wiil the regulators force the large banks to show any increase in loan impairment. Again, given the incredible political clout of the financial sector, I doubt it.

We have experienced one of the most robust corporate profit recoveries on record over the last half century. We know reported financial sector earnings are questionable at best, but the regulators will do absolutely nothing to change that.

So once again we find ourselves in a period of Fed sponsored asset appreciation. The thought, of course, being that if stock prices levitate so will consumer confidence. Which, according to Mr. Bernanke will lead to increased spending and a virtuous circle of economic growth. Oh really? The final chart below tells us consumer confidence is not driven by higher stock prices, but by job growth.

9 - CHRONIC UNEMPLOYMENT

There are 3 major inflationary drivers underway.

1- Negative Real Interest Rates Worldwide - with policy makers' reluctant to let their currencies appreciate to market levels. If no-one can devalue against competing currencies then they must devalue against something else. That something is goods, services and assets.

2- Structural Shift by China- to a) Hike Real Wages, b) Slowly appreciate the Currency and c) Increase Interest Rates.

3- Ongoing Corporate Restructuring and Consolidation - placing pricing power increasingly back in the hands of companies as opposed to the consumer.

FOOD PRICE PRESSURES

RICE: Abdolreza Abbassian, at the FAO in Rome, says the price of rice, one of the two most critical staples for global food security, remains below the peaks of 2007-08, providing breathing space for 3bn people in poor countries. Rice prices hit $1,050 a tonne in May 2008, but now trade at about $550 a tonne.

WHEAT: The cost of wheat, the other staple critical for global food security, is rising, but has not yet surpassed the highs of 2007-08. US wheat prices peaked at about $450 a tonne in early 2008. They are now trading just under $300 a tonne.

The surge in the FAO food index is principally on the back of rising costs for corn, sugar, vegetable oil and meat, which are less important than rice and wheat for food-insecure countries such as Ethiopia, Bangladesh and Haiti. At the same time, local prices in poor countries have been subdued by good harvests in Africa and Asia.

 

- In India, January food prices reflected a year-on-year increase of 18%t.

- Buyers must now pay 80%t more in global markets for wheat, a key commodity in the world's food supply, than they did last summer. The poor are especially hard-hit. "We will be dealing with the issue of food inflation for quite a while," analysts with Frankfurt investment firm Lupus Alpha predict.

- Within a year, the price of sugar on the world market has gone up by 25%.

US STOCK MARKET VALUATIONS

 

WORLD ECONOMIC FORUM

Potential credit demand to meet forecast economic growth to 2020


The study forecast the global stock of loans outstanding from 2010 to 2020, assuming a consensus projection of global
economic growth at 6.3% (nominal) per annum. Three scenarios of credit growth for 2009-2020 were modelled:


• Global leverage decrease. Global credit stock would grow at 5.5% per annum, reaching US$ 196 trillion in 2020. To
meet consensus economic growth under this scenario, equity would need to grow almost twice as fast as GDP.
• Global leverage increase. Global credit stock would grow at 6.6% per annum, reaching US$ 220 trillion in 2020.
Likely deleveraging in currently overheated segments militates against this scenario.
• Flat global leverage. Global credit stock would grow at 6.3% per annum to 2020, tracking GDP growth and reaching
US$ 213 trillion in 2020 – almost double the total in 2009. This scenario, which assumes that modest
deleveraging in developed markets will be offset by credit growth in developing markets, provides the primary credit
growth forecast used in this report.

Will credit growth be sufficient to meet demand?


Rapid growth of both capital markets and bank lending will be required to meet the increased demand for credit – and it is
not assured that either has the required capacity. There are four main challenges.


Low levels of financial development in countries with rapid credit demand growth. Future coldspots may result from the
fact that the highest expected credit demand growth is among countries with relatively low levels of financial access. In
many of these countries, a high proportion of the population is unbanked, and capital markets are relatively undeveloped.


Challenges in meeting new demand for bank lending. By 2020, some US$ 28 trillion of new bank lending will be
required in Asia, excluding Japan (a 265% increase from 2009 lending volumes) – nearly US$ 19 trillion of it in China
alone. The 27 EU countries will require US$ 13 trillion in new bank lending over this period, and the US close to US$
10 trillion. Increased bank lending will grow banks’ balance sheets, and regulators are likely to impose additional capital
requirements on both new and existing assets, creating an additional global capital requirement of around US$ 9 trillion
(Exhibit vi). While large parts of this additional requirement can be satisfied by retained earnings, a significant capital gap in
the system will remain, particularly in Europe.

The need to revitalize securitization markets. Without a revitalization of securitization markets in key markets, it is doubtful
that forecast credit growth is realizable. There is potential for securitization to recover: market participants surveyed by
McKinsey in 2009 expected the securitization market to return to around 50% of its pre-crisis volume within three years.
But to rebuild investor confidence, there will need to be increased price transparency, better data on collateral pools, and
better quality ratings.


The importance of cross-border financing. Asian savers will continue to fund Western consumers and governments:
China and Japan will have large net funding surpluses in 2020 (of US$ 8.5 trillion and US$ 5.7 trillion respectively), while
the US and other Western countries will have significant funding gaps. The implication is that financial systems must
remain global for economies to obtain the required refinancing; “financial protectionism” would lock up liquidity and stifle
growth.

 

US$ RESERVE CURRENCY

SocGen crafts strategy for China hard-landing

Société Générale fears China has lost control over its red-hot economy and risks lurching from boom to bust over the next year, with major ramifications for the rest of the world.

Société Générale said China's overheating may reach 'peak frenzy' in mid-2011

- The French bank has told clients to hedge against the danger of a blow-off spike in Chinese growth over coming months that will push commodity prices much higher, followed by a sudden reversal as China slams on the brakes. In a report entitled The Dragon which played with Fire, the bank's global team said China had carried out its own version of "quantitative easing", cranking up credit by 20 trillion (£1.9 trillion) or 50pc of GDP over the past two years.

- It has waited too long to drain excess stimulus. "Policy makers are already behind the curve. According to our Taylor Rule analysis, the tightening needed is about 250 basis points," said the report, by Alain Bokobza, Glenn Maguire and Wei Yao.

- The Politiburo may be tempted to put off hard decisions until the leadership transition in 2012 is safe. "The skew of risks is very much for an extended period of overheating, and therefore uncontained inflation," it said. Under the bank's "risk scenario" - a 30pc probability - inflation will hit 10pc by the summer. "This would cause tremendous pain and fuel widespread social discontent," and risks a "pernicious wage-price spiral".

- The bank said overheating may reach "peak frenzy" in mid-2011. Markets will then start to anticipate a hard-landing, which would see non-perfoming loans rise to 20pc (as in early 1990s) and a fall in bank shares of 50pc to 75pc over the following 12 months. "We think growth could slow to 5pc by early 2012, which would be a drama for China. It would be the first hard-landing since 1994 and would destabilise the global economy. It is not our central scenario, but if it happens: commodities won't like it; Asian equities won't like it; and emerging markets won't like it," said Mr Bokobza, head of global asset allocation. However, it may bring down bond yields and lead to better growth in Europe and the US, a mirror image of the recent outperformance by the BRICs (Brazil, Russia, India and China).

- Diana Choyleva from Lombard Street Research said the drop in headline inflation from 5.1pc to 4.6pc in December is meaningless because the regime has resorted to price controls on energy, water, food and other essentials. The regulators pick off those goods rising fastest. The index itself is rejigged, without disclosure. She said inflation is running at 7.6pc on a six-month annualised basis, and the sheer force of money creation will push it higher. "Until China engineers a more substantial tightening, core inflation is set to accelerate.

- The longer growth stays above trend, the worse the necessary downswing. China's violent cycle could be highly destabilising for the world." Charles Dumas, Lombard's global strategist, said the Chinese and emerging market boom may end the same way as the bubble in the 1990s. "The basic strategy of the go-go funds is wrong: they risk losing half their money like last time."

- Société Générale said runaway inflation in China will push gold higher yet, but "take profits before year end".

- The picture is more nuanced for food and industrial commodities. China accounts for 35pc of global use of base metals, 21pc of grains, and 10pc of crude oil. Prices will keep climbing under a soft-landing, a 70pc probability. A hard-landing will set off a "substantial reversal". Copper is "particularly exposed", and might slump from $9,600 a tonne to its average production cost near $4,000. Chinese real estate and energy equities will prosper under a soft-landing,

- The bank likes regional exposure through the Tokyo bourse, which is undervalued but poised to recover as Japan comes out of its deflation trap. If you fear a hard landing, avoid the whole gamut of Chinese equities. It will be clear enough by June which of these two outcomes is baked in the pie.

SocGen crafts strategy for China hard-landing Pritchard

PUBLIC SENTIMENT & CONFIDENCE

 

 

SHRINKING REVENUE GROWTH RATES

PIMCO'S NEW NORMAL: According to PIMCO, the coiners of the term, the new normal is also explained as an environment wherein “the snapshot for ‘consensus expectations’ has shifted: from traditional bell-shaped curves – with a high likelihood mean and thin tails (indicating most economists have similar expectations) – to a much flatter distribution of outcomes with fatter tails (where opinion is divided and expectations vary considerably).” That is to say, the distribution of forecasts has become more uniform (as per Exhibit 1).

Riots in Egypt over Food Prices and Unemployment; Protests Spread to Algeria, Morocco and Yemen; Twitter in the Spotlight

Protesters are angry over poverty, rising food prices, state food subsidies, unemployment, and social conditions.

Social media outlets, especially Twitter have played a leading role in organizing protests

Tens of thousands turned out for the largest protests in Egypt in years — inspired by the uprising in Tunisia. They demanded Mubarak's ouster and a solution to grinding poverty, rising prices and high unemployment. Thousands of protesters burned tires, threw Molotov cocktails at a government building and fought riot police in Egypt yesterday in the worst unrest in President Hosni Mubarak's 30-year-old rule. The 82-year-old Mubarak, who came to power in 1981 after President Anwar Sadat was assassinated, has been the target of growing anger over the country's poverty, corruption and repression.

The ongoing anti-government protests on the streets of Cairo and other Egyptian cities represent the biggest public demonstration in the country since the famous ‘bread riots’ which occurred exactly 34 years ago. The current riots, while more dedicated to the overthrow of President Hosni Mubarak, are also partially incited by rising food prices.

Discontent with life in Egypt's authoritarian police state has simmered under the surface for years. However, it is Tunisia's popular uprising, which forced that nation's autocratic ruler from power, that appears to have pushed young Egyptians into the streets, many for the first time. "This is the first time I am protesting, but we have been a cowardly nation. We have to finally say no," said Ismail Syed, a hotel worker who struggles to live on a salary of $50 a month. "We want to see change, just like in Tunisia," said 24-year-old Lamia Rayan. Dubbed a "day of revolution against torture, poverty, corruption and unemployment," Tuesday's protests in cities across Egypt began peacefully, with police at first showing unusual restraint in what appeared to be a calculated strategy to avoid further sullying the image of a security apparatus widely criticized as corrupt and violent.

Protests Spread to Algeria, Morocco, Jordan, Yemen

Bloomberg reports North African Unrest May Spread on Record Food Prices

Blood on Bernanke's Hands

Most of the increases in food prices are due to droughts in South America, floods in Australia, and poor growing conditions in many places.

However, Bernanke's "Quantitative Easing" policies combined with rampant credit growth in China and India have led to increased speculation in commodities. That speculation has forced up food prices.

If you are tweeting, please tweet this "Bernanke has blood on his hands".


Please note that speculation in commodities is not a cause of anything. Rather commodity speculation is a result of piss poor monetary policies not only the Fed, but central bankers worldwide.


Near-Death LBOs Thrive in Bernanke Bond Market : Credit Markets

The biggest leveraged buyouts from the takeover boom, once seen as almost certain bankruptcies by derivatives traders, are seeing borrowing costs tumble to the lowest since 2007.

Credit-default swaps on Clear Channel Communications Inc., Univision Communications Inc., Freescale Semiconductor Inc. and former Harrah’s Entertainment Inc., which in February 2009 priced in an average 99.8 percent chance of default, now imply 46.6 percent odds of a collapse, according to data compiled by Bloomberg. Harrah’s bonds have soared to 97 cents on the dollar from 13 cents two years ago.

As the Federal Reserve holds benchmark interest rates near zero to stimulate the economy, Blackstone Group LP, KKR & Co. and other private-equity firms are taking advantage of record investor demand for high-yield debt to refinance buyout-related loans and bonds. Last year saw $93 billion worth of leveraged buyouts worldwide, more than triple the figure in 2009, according to Bloomberg data.

“You have a lot of money searching for yield, and when that happens, a lot of folks can get money regardless of the situation of their balance sheet and income statement,” said Lon Erickson, a money manager who helps oversee $9 billion of fixed-income assets for Thornburg Investment Management Inc. in Santa Fe, New Mexico.

Yields on the bottom tier of junk debt, with ratings of CCC and lower, declined to within 8.12 percentage points of Treasuries this week, the least since November 2007, according to Bank of America Merrill Lynch index data. The spread widened to 44.3 percentage points in December 2008 in the aftermath of Lehman Brothers Holdings Inc.’s bankruptcy.

Distressed Sales

Realogy Corp. led $4.8 billion of sales this month by companies graded Caa1 or lower by Moody’s Investors Service, after $43.7 billion in 2010, Bloomberg data show. Last year’s issuance was triple the $14.1 billion in 2009.

Some LBOs still face challenges to refinance debt, including Energy Future Holdings Corp., the largest buyout in history. Swap prices are 1,908.6 basis points on Energy Future after natural gas prices slumped following KKR and TPG Capital’s $43.2 billion takeover of the former TXU Corp. in 2007. That implies an 81 percent chance of default within five years, CMA data show.

Lisa Singleton, a spokeswoman for Dallas-based Energy Future, declined to comment.

Relative Yields

Elsewhere in credit markets, the extra yield investors demand to own company bonds worldwide instead of similar maturity government debt was unchanged at 160 basis points, or 1.6 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.948 percent.

The risk of Egypt defaulting rose to the highest since May 2009 as protests against President Hosni Mubarak’s rule spread.

Credit-default swaps on the country’s bonds climbed 9 basis points to 385, according to CMA. That added to a 26 percent jump this week, the most since October 2008.

Bonds from New York-based Morgan Stanley were the most actively traded U.S. corporate securities by dealers yesterday, with 127 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Marathon Petroleum Corp. sold $3 billion of bonds, the biggest non-financial U.S. offering in almost three months, as it prepares to be spun off from Marathon Oil Corp.

The $750 million of five-year securities pay 155 basis points more than similar-maturity Treasuries and the $1 billion of 10-year notes yield 175 basis points more than benchmarks, Bloomberg data show. The $1.25 billion of 30-year bonds pay a 200 basis-point spread.

Biggest Sale

The offering is the biggest by a non-financial U.S. company since Coca-Cola Co. sold $4.5 billion of debt on Nov. 4, Bloomberg data show. Petroleo Brasileiro SA issued $6 billion of bonds last week, the largest non-financial offering this year, the data show.

Commercial paper outstanding increased for the first time since October, led by financial issuers as bank lending to companies is poised to rise for a third straight month. The seasonally adjusted market for short-term IOUs rose $71.1 billion to $988.4 billion, the biggest increase since January 2009, Bloomberg data show.

Leveraged Loans

The Standard & Poor’s/LSTA US Leveraged Loan 100 Index gained for a fourth day yesterday, rising 0.11 cent to 96 cents on the dollar, the highest level since November 2007. The index tracks the 100 largest dollar-denominated first-lien leveraged loans.

Leveraged loans and junk bonds are rated below Baa3 at Moody’s or less than BBB- at S&P.

Continental AG, Europe’s second-biggest tiremaker, began talks with lenders to refinance 5.3 billion euros ($7.3 billion) in loans coming due next year, according to three people with knowledge of the discussions, who asked not to be identified because the negotiations are confidential.

Toyota Motor Corp. sold $1 billion of bonds through its finance arm in an offering backed by auto loans, according to a person familiar with the transaction. A $273 million slice maturing in one year yields 17 basis points more than benchmark rates, said the person, who declined to be identified because terms aren’t public.

In emerging markets, relative yields increased 9 basis points to 244 basis points, according to JPMorgan Chase & Co. index data.

Clear Channel Swaps

The average cost of default swaps on Clear Channel, Univision, Freescale and Caesars Entertainment Corp., the Las Vegas-based casino operator formerly called Harrah’s, declined to 736 basis points from 8,963 in February 2009, as the economy recovers from the worst recession since the 1930s and access to debt markets opens for even the least creditworthy companies.

Current prices mean it would cost the equivalent of $736,000 a year to protect $10 million of debt against default for five years.

Swaps on Clear Channel’s debt dropped by 50 percent since June to 922.3, the lowest level since May 2008, CMA data show.

At their peak, the contracts priced in 100 percent odds the San Antonio-based company would default within five years, based on an expectation that investors would recover 40 percent of face value of the bonds if it failed to meet its obligations, CMA data show. Prices now imply a 55 percent probability of default for the company, bought by Bain Capital Partners LLC and Thomas H. Lee Partners LP for $17.9 billion in July 2008.

Swaps on Freescale dropped yesterday to 579.3 basis points, the least since November 2007, CMA prices show.

‘Never Missed Payment’

“Freescale did not default on its debt and we have never missed an interest payment since going private in 2006,” said Robert Hatley, a spokesman for the Austin, Texas-based company, which was taken private by Blackstone, Carlyle Group, Permira Advisers LLP and TPG for $17.6 billion in 2006.

Contracts on Caesars, purchased by Leon Black’s Apollo Management LP and TPG for $30.7 billion, fell to 901 basis points on Jan. 3, the lowest since January 2008. The casino operator’s $470.5 million of 10.75 percent notes due in 2016 rose to 97 cents on the dollar yesterday, after plunging to 13 cents in February 2009.

Swaps on U.S. Spanish-language broadcaster Univision, bought for $13.7 billion in 2007 by investors including Madison Dearborn Partners LLC, are down 56 percent from February 2010 and reached 533.2 basis points on Jan. 5, the least since November 2007.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt.

Univision Bonds

New York-based Univision issued $315 million of 8.5 percent debt on Jan. 10, graded Caa2 by Moody’s and CCC+ by S&P, Bloomberg data show.

Moody’s raised its outlook on Univision to stable from negative in October after the company planned a refinancing and resolved a licensing dispute with Mexico’s Grupo Televisa SA.

A so-called maturity wall of loans and bonds maturing through 2014 that JPMorgan estimated in November at $756 billion is being reduced as speculative-grade companies sell debt and amend credit agreements to push out repayment schedules. High- yield companies have issued $27.7 billion this year, following a record $287.2 billion in 2010, Bloomberg data show. The maturity wall was reduced by at least $393 billion since the start of 2009, according to JPMorgan.

Spreads Narrow

Relative yields on speculative-grade bonds declined 42 basis points this month to 499 basis points, Bank of America Merrill Lynch index data show. It fell below 5 percentage points on Jan. 26 for the first time since Nov. 8, 2007.

“A lot of this is happening because of the very accommodative monetary policy by the Fed,” said Hans Mikkelsen, an analyst at Bank of America Merrill Lynch Global Research in New York. “The real test of this will be what happens when the Fed gets closer to actually withdrawing some of this liquidity from the markets.”

Fed Chairman Ben S. Bernanke and his colleagues said this week they are maintaining plans to buy $600 billion of Treasuries through June, as the central bank seeks to reduce unemployment. The Fed left its benchmark interest rate in a range of zero to 0.25 percent, where it’s been since December 2008, and retained a pledge in place since March 2009 to keep it “exceptionally low” for an “extended period.”

Liquidity Grades

The number of companies with Moody’s lowest liquidity grades declined to 29 in December, or 5.1 percent of rated companies, from 8.6 percent a year earlier. The issuers, which rely on external sources of financing with “highly uncertain” availability, oversee about $64.9 billion of debt, Moody’s said in a report this month.

LBOs “in general are obviously very dependent on refinancing,” Moody’s analyst John Puchalla said. “The terms of refinancing have gotten cheaper from a company perspective.”

The 12-month trailing speculative-grade default rate in the U.S. declined for the 13th month in a row to 3.27 percent in December from 11.1 percent at the end of 2009, S&P said in a Jan. 25 report. The ratings company predicts that will fall to 2.4 percent in September.

Bond investors are also speculating that leveraged buyouts will benefit from a rebound in equity values, as the S&P 500 Index surges 92 percent from its 12-year low in March 2009. More than half of the U.S. initial public offerings planned for this year were from private-equity firms as of the start of this month, Bloomberg data show.

Private Equity

Nielsen Holdings NV, the television company owned by Blackstone, Carlyle, KKR and Thomas H. Lee Partners, raised $1.6 billion this week in the biggest private-equity backed U.S IPO since 2006.

“You may see a stronger IPO market this year than you’ve seen in the last couple of years,” Bank of America Merrill Lynch’s Mikkelsen said. “That’s really a prerequisite for a lot of these companies to improve their capital structure, to issue equity.”

The world’s largest buyout funds are planning a new round of takeovers. KKR is seeking to raise $8 billion to $10 billion for a new fund, while Blackstone’s co-founder Stephen Schwarzman said in an interview with Bloomberg TV at the World Economic Forum in Davos, Switzerland, there is capital to fund leveraged buyouts of as much as $10 billion as debt becomes more available.

“We’re all absolutely shocked at how fast leverage snapped back from where we were, say, two years ago,” said William Welnhofer, a managing director at Robert W. Baird & Co. in Chicago. “I don’t think anyone who’s honest would have expected such a move.”

ECB Warns (Threatens) of Risk of Bank Run

Any attempt by the Government to impose losses on senior bondholders would spark a "run" on banks and undermine confidence, a senior member of the European Central Bank has said. "The amount of senior bonds is so small compared to the overall amount that if you do a haircut to the bonds, immediately you would have a run on banks by the Irish themselves," European Central Bank executive board member Lorenzo Bini Smaghi said in an interview with RTÉ last night. "They would not trust anymore that their assets held on the banks are safe."

The Government introduced legislation last month allowing it to impose discounts on subordinated bondholders at banks bailed out by the state, leaving senior bondholder untouched. Senior bank bondholders are ranked the same as depositors under Irish law.

Minister for Finance Brian Lenihan told the Dáil yesterday it would be "very difficult" for any government to reach an agreement at a European level to impose discounts on banks' senior bondholders. Mr Lenihan said he raised the matter with the ECB, which refused to consider it.

Mr Bini Smaghi also echoed remarks by French president Nicolas Sarkozy, who called on Ireland to consider raising its 12.5 percent corporate tax rate. Sarkozy said last month the country can't have "the lowest corporate taxes in the euro zone and then transfer" its debt. "Ireland wants to stick to its own tax system but then doesn't want its taxpayer to pay for it," Mr Bini Smaghi said. "It wants the others taxpayers to pay for it, so I think we have to address that." Fine Gael leader Enda Kenny said he will seek to renegotiate the details of Ireland's bailout.

Bini Smaghi said that terms for Ireland's financial-support package are "more or less standard" and that authorities "try to apply equal treatment for everybody". The ECB will continue to support the Irish banking system, he said, adding that the government must stick to its
austerity measures.

"Unfortunately, among financial markets certain parts have an interest if a country defaults," he said. "It's certainly not in the interest of the Irish people if Ireland defaults because the impact of a default would fall on the Irish people in a dramatic way."

Mr Kenny is scheduled to meet European Commission president Jose Manuel Barroso in Brussels today.