I will destroy this village in order to save it!

Can you identify where the title of this post comes from? (Most likely other places, too.)

I was reading this three part series on how a space war with China will affect space assets well beyond the scope of any actual conflict. The relevant quote:

But if the short term military consequences to the United States are not that bad, the long term consequences to all space-faring nations would be devastating.  The destruction … satellites hit during the first hour of the attack considered here could put over 18,900 new pieces of debris over four inches in diameter into the most populated belt of satellites in low Earth orbit. … [Over the course of] the next year or so—well after the terrestrial war with China had been resolved—the debris fields would fan out and eventually strike another satellite. 

These debris fields could easily cause a run-away chain of collisions that renders space unusable — for thousands of years, and for everyone.  Not only is this a quickly growing and important sector of the world’s economy … , but space is also used for humanitarian missions …

Interestingly, it seems like this is exactly what’s going on in the securtization markets right now. Conduits, or investment banks that commit their own capital for making loans which aren’t meant to be held, only securitized, are basically shut down. Why are they shut down? Spreads on Commercial Mortgage Backed Securities have reached astronomical levels relative to where they have been, making it completely uneconomical for re-financing. The longer the conduits stay shut down, the more they downsize. The more they downsize, the less capacity there is. The less capacity there is, the more illiquid the mortgage market becomes for borrowers due to the lack of ability to create new bonds. (This is a very nuanced cause and effect, but many players only buy “new issue” bonds and many indices track newly issued bonds. Once there is a lack of new bonds and those indices become concentrated in older bonds that may have been more aggressively underwritten the sector could become unattractive.) From here, two things happen: borrowers start defaulting because they can’t get new loans, and the aforementioned illiquidity in bonds backed by these loans (in an environment where risk, in the form of defaults, is rising) causes spreads to move even wider (larger spreads = higher rates on commercial mortgages).

Well, this pattern continues, and even the WSJ is talking about how little sense it makes.  (FYI–Caveat emptor for people who consume the WSJ stories on complex derivatives products. There are some issues with how it describes these that I will discuss in a later post.)

At what point would one decide to exit such a market? When does a market seem completely unattractive? Was this disaster necessary to ensure a return to sound credit analysis? Only time will tell.

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