Friday, February 6, 2009

Credit Crisis: A Quick Analysis

In case you find yourself in a party talking about the credit crisis, here are some major points which you can do further research on to understand exactly what happened to the market and what will happen in the foreseeable future.

There were many indicators last year that margins on investment returns were starting to shrink. In the M&A market, LBO's were being done on less profitable companies. PE ratios were off the scale. There were record highs in stock prices. Securities instruments and financial innovation became more complicated (recursive CDOs, debt instruments and waterfall trenches). As the market was flooded with capital, there were less places to find a good return.

After the crash, confidence was shattered in the market. The debt instruments rated AAA which should have been "investment grade" were worthless.

The questions that bankers and investors are asking are:
  • What needs to happen to the debt markets to reinstate confidence?
  • What systematically needs to change in the ratings system?
  • Interest rates are at their lowest rates ever (near 0). Being unable to further drop rates beyond 0, what else will be done to encourage banks to lend and people to borrow?
  • When will the economy recover? And in what windows will each sector recover?

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