The Big Squeeze

THE symbolism is almost too perfect. According to TheStreet.com, a financial website, John Devaney, a hedge-fund manager, has put his 142-foot yacht Positive Carry up for sale, along with his 16-bedroom mansion in Aspen, Colorado. Funds run by Mr Devaney's group, United Capital, have had to halt payouts to investors after making heavy losses on mortgage-backed bonds.
Ironically, Mr Devaney's early life pointed to the excesses that were to come. He used his student credit card to buy a house, on which he took out a second mortgage. But Mr Devaney's recklessness was not unusual in the recent global debt bonanza, where rash lending became commonplace. Bank executives will be haunted by memories of Ninja loans (to people with No Income, No Job or Assets) and Pik toggles (agreements that gave firms the right to pay interest in the form of further IOUs rather than cold, hard cash).
Hedge-fund managers, such as Mr Devaney, were happy to borrow money to buy those loans because they made the “positive carry” that he boasted about; ie, the return on their holdings was greater than the cost of financing them. What they forgot was that relying on positive carry alone comes with a risk: that the debtor will not repay the loan.
Now, at last, investors and lenders have woken up. Credit spreads, the premium that riskier borrowers must pay over government debt, have surged since June. That is a problem for companies and banks in the middle of doing deals. Financing packages for the takeovers of Alliance Boots, a British health-care chain, and Chrysler, America's third-biggest car giant, have been postponed. Merrill Lynch says some 35 bond or loan deals have been cancelled or restructured in the past five weeks. And it is not just the riskiest borrowers that have been affected. Globally, only $98 billion of investment-grade bonds (to the most creditworthy borrowers) were issued in July, the lowest since August 2004.