This deal's getting worse all the time!

I was going to write a post about the Sallie Mae news, since LBO's have been a common topic on this blog in 2007. But as I started to write, I realized I didn't have anything to say that I haven't already said either here or here. I think the end-game here is a renegotiated price, and I think that's why the stock is considerably higher today.


On the liquidity front, things have improved greatly. Spreads on generic product have moved mildly tighter from the recent wides:

• Lehman High Yield Credit OAS now 400, was as wide as 465 on 9/10
• Lehman IG OAS now 132, was as wide as 143 on 9/17
• Lehman MBS OAS now 81, was as wide as 91 on 8/16

But all are much wider than recent tights:

• High Yield was as tight as 233 on 5/29
• IG was as tight as 82 on 5/29
• MBS was as tight as 47 on 4/9

But the move hasn't been indiscriminant. The ABX-07-1 BBB- index continues to hit new lows...

While the AA index has improved substantially...

Homebuilders continue to perform poorly (Centex's CDS)...


While mortgage market participants with strong access to liquidity are doing well (WaMu CDS)...


So this begs the question: if conditions remain as they are today, does the Fed need to cut further? Maybe. Remember that by my estimate, the Taylor rule still says policy is too tight, and I'm not alone in that view. So that would suggest that additional cuts are coming, and the liquidity crisis has nothing to do with anything. On the other hand, one cannot deny that the Fed choose to surprise the market with a 50bps cut for a reason. For the last 4 years or so, the Fed has always telegraphed its moves like a Notre Dame quarterback, then all of a sudden they decide to shock the market with a huge cut. This was obviously aimed at curbing the liquidity crunch. And to take that one step further, they probably choose to shock the market in the hopes that they could get away with fewer cuts in total.

So I think the odds of no move on Oct 31 are a bit higher than the 30% or so currently priced into funds futures. But then again, always in motion the futures are.