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June 22, 2007

Signs Of The Times
by Bob Hoye

Signs Of The Times:

The front page article included a chart titled "Mound of Debt" that showed the exponential growth of the face value of leveraged loans. These are defined as speculative-grade loans and unrated loans at interest rates of 1.25 points or more above Libor.

From almost nothing in 1996 the "mound" has soared from $240 billion in 2005, $400 billion outstanding at the end of 2006, to $480 billion as of May 31.

The fund is run by Bear Sterns and is called High Grade Structured Credit Strategies Enhanced Leveraged Fund. By our simple reckoning this comes out as financial engineering or as celebrated by Tokyo in 1989 "Zaitech".

This reminds of the old observation that in a contraction it can be difficult, if not impossible, even for AAA ratings to obtain loans, while in a boom it's impossible for any credit to refuse a loan.

The latter seems to be the case now and it seems likely that the lenders are carrying the loans on their books at par.

It's worth reviewing lending conditions. As the great bear market in bonds (1946 to 1981) was becoming rather distressed the market for treasuries was a disaster, the corporate market was worse, and there was virtually no such thing as a "Sovereign Market".

Notwithstanding this, the big banking syndicates out of New York continued to make loans to a variety of "Sovereign" borrowers and despite the unique turmoil in the credit markets, were insisting that the loans would be kept on the books at par. The thinking was that because countries always met their obligations their loans would always be worth par.

This delusion went on longer than it should have when a small bank away down the selling group decided in all honesty that it was going to mark its position to market.

The big banks insisted that this need not, nor should not, be done. The small bank, which was located outside New York, must have been managed by bankers, rather than economists, because common sense prevailed and the big banks were forced to mark their portfolios of doubtful paper to market.

As Wall Street Journal observes, there are mounds of doubtful paper out there.

Bob Hoye
Institutional Advisors

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

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Copyright © 2003-2008 Bob Hoye

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