Good Basic Article on Leverage and the Crisis

From James Saft of Reuters:

October 24th, 2008

Distortion is the new normal for markets

Posted by: James Saft
Tags: Uncategorized, Credit crisis

(James Saft is a Reuters columnist. The opinions expressed are his own.)

LONDON (Reuters) – The evaporation of borrowed money has fundamentally changed the way markets function, and what look like crazy anomalies may end up being closer to the new reality.

Across financial markets, especially in fixed income, strange things are happening. Take two examples:

The U.S. government takes Fannie Mae and Freddie Mac into conservatorship, essentially guaranteeing their debts. Investors first narrow the premium they demand to lend to the two mortgage giants, then stage a strike and send these premiums to all-time highs.

Treasury inflation-protected securities (TIPs) hugely underperform standard Treasuries, and are factoring in precious little inflation in comparison to market expectations.

And while fundamental explanations and official policy errors may explain some such moves, they probably don’t account for all of them.

The common denominator is the rapid disappearance from the market of leverage, money borrowed by investors to magnify what they can buy.

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