Credit mess likely to hurt leveraged buyouts

The Baltimore Sun

This has been the month of clenched teeth beneath smiles.

Investors haven't liked the underlying threats posed by the mortgage mess and the way lenders doled out billions of dollars to businesses and homeowners who wanted it - even if they could not afford to repay.

But with the Dow Jones industrial average hitting new highs day after day earlier this month, investors kept wearing tense smiles and stayed to play in the market despite the uneasiness.

That changed last week when it became clear that housing troubles are not as contained as some of Wall Street's elite have suggested, and the feared spillover into the financial system had begun.

In response, investors dumped stocks last week. And investors with high-yield bonds came to recognize the riskiest of bonds for what they are - junk.

"It's like a switch has been flipped," said bond manager Marilyn Cohen, of Envision Capital in Los Angeles.

A few weeks ago, she said, investors were willing to buy high-yield bonds, even though they were paid comparatively little interest to take on the risk that a company would default on payments to bond investors.

Last week, Cohen said, as investors became nervous about housing and the potential that companies wouldn't get the easy money they were expecting, investors wanted to sell their junk bonds, but couldn't find buyers.

Investors have been on edge throughout July as certain pieces of mortgage-related bond investments called collateralized debt obligations, or CDOs, have become virtually worthless.

The value of the securities depends on homeowners making monthly payments. As adjustable rates on mortgages have risen to unaffordable levels, many homeowners have been unable to pay.

Until last week, the problem seemed to be contained in subprime loans, or mortgages that go to people with bad credit scores, which make up about 14 percent of mortgages. But investors became unnerved when they discovered that even loans to people with seemingly solid credit were going bad.

Countrywide Financial Corp., the biggest U.S. mortgage lender, reported last week that so many borrowers were behind with mortgage payments, its second-quarter profits tumbled 33 percent. Further, chief executive Angelo R. Mozilo said he expects the "difficult housing and mortgage market conditions to persist" through this year and possibly to 2009.

Bloomberg News reported that Mozilo said, "We are experiencing home price depreciation almost like never before, with the exception of the Great Depression."

Other mortgage lenders - including Bank of America - also reported problems with home-equity loans that supposedly went to solid borrowers.

And in a sign that the housing recession is hurting other companies, DuPont, which makes products for homes, reported that profits were weaker than investors were expecting. The stock fell 6.3 percent in a day.

Besides the concern that a slowdown in home building would affect other companies, and that financially stressed consumers will be reluctant to shop, investors also worried that lenders will turn squeamish. They fear the lenders will cut off the leveraged buyouts that have been propelling the market, and especially mid-cap stocks, to record-breaking levels for months.

"The tide appears to be going out for levered equity financiers," said William H. Gross, chief investment officer at Pacific Investment Management Co. (Pimco).

gmarksjarvis@tribune.com

Gail MarksJarvis writes for Tribune Media Services. For more on managing your money, see her blog at www.chicagotribune.com/money.

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