Assessing the Damage of the 2007 Liquidity Crisis

Location: Greenwich
Author: Ryan Utsumi
Date: Monday, September 24, 2007
 

Greenwich Associates surveyed 251 institutional investors in North America, Europe and Asia about the extent and ramifications of the liquidity crisis that began in the U.S. sub-prime sector this summer.

The asset management firms, banks, hedge funds and other institutions participating in the study report that trading in various credit-related products and asset classes has broken down entirely at certain times since the outbreak of the crisis. In addition, a large majority of plan sponsors report that recent market developments have shaken their confidence in credit rating agencies.

Among survey participants active in asset-backed securities (ABS) and collateralized debt obligations (CDOs), more than 80 percent say they have experienced difficulty in obtaining a price quote from their fixed-income dealers on these products since the outbreak of the market turmoil. Almost 80 percent of the collateralized loan obligation (CLO) users responding to the survey and nearly 70 percent of the leveraged loan investors say they have had trouble getting a dealer quote on the products, as did nearly 65 percent of survey participants active in mortgage-backed securities (MBS) and more than 60 percent of commercial mortgage-backed securities (CMBS) investors.

“In perhaps the clearest indication of the severity and extent of the liquidity disruption, more than 60% of participants active in corporate bonds say they have experienced trouble getting a simple price quote from dealers on these usually liquid products,” says Greenwich Associates consultant Tim Sangston. “It’s hardly an exaggeration to call this a total market breakdown.”

More than three-quarters of the institutional investors responding to the Greenwich Associates survey believe that the liquidity crisis will continue to spread into products and markets beyond mortgages, collateralized debt obligations and other structured products. “However, the investors are divided when it comes to the question of whether the current liquidity crunch represents a short-term event or a structural crisis,” says Greenwich Associates consultant Lori Crosley. “Fifty-five percent of study participants see the liquidity crunch as a structural crisis, while 45 percent see it as a short-term event.”

More than 45 percent of study participants say they have 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. The moves were almost universally in the same direction: away from risk in general and from mortgage and real estate exposure in particular, and into higher-rated instruments, especially shorter-duration government securities. “Institutions are also focused on limiting counterparty-risk in an atmosphere in which the full extent of the losses and exposures of individual counterparties can be difficult if not impossible to ascertain,” says Greenwich Associates hedge fund specialist Karan Sampson.

Nearly a third of the institutional investors participating in the study say they are liquidating positions/portfolios in order to mitigate the risks posed by turbulent credit markets and roughly half say the recent performance of CDOs and other structured products has made them less likely to invest in these products in the future. “A sizable share of participants say they have stopped investing in fixed income altogether for the time being,” says Greenwich Associates consultant Frank Feenstra.

Almost 70 percent of participating investors that use leverage in their portfolios say they have left overall leverage levels unchanged throughout the market turmoil. In individual products, however, investors have been cutting back. More than 40 percent of study participants active in the CDO market say they have reduced leverage in their portfolios, as did almost 40 percent of CMBS investors.

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