Credit Squeeze – Could it Help to Cool Overheating Markets?

Although it may be of little consolation to investors, the recent credit squeeze could be just what is needed to help overheating markets cool down. Despite not being early enough to rescue the US housing market from crashing, it could still prove a blessing in disguise in helping to dampen the takeover boom from escalating to an uncontrollable level.

Debt markets will have to try to cope with huge impacts on a global scale. Hopefully lenders and borrowers alike will have learnt their lessons from the events of the past six months. Lending standards will be tightened, resulting in less risky lending deals such as PIK notes or ‘payment in kind’ notes, which are agreements where IOUs can be issued in place of cash payment on interest.

With great nervousness surrounding the debt markets at this moment in time, investors will be avoiding takeovers in this area. The stockmarket, which had been experiencing highs on the back of debt market takeovers, will find share prices continuing to fall. The majority of businesses shouldn’t have any major difficulties in accessing debt however, but they must expect the cost of this to rise. A great many firms have no significant borrowing requirements, as they find themselves cash-rich from activities conducted over the past few years, when flourishing investments paid off.

One of the most important factors in the survival of the global economy in the midst of a credit squeeze is the need for consumers (particularly within the American economy) to continue spending. Decreasing house prices and increasing oil prices have already contributed to a marked slowdown in US consumption. It is hoped that the buoyant global economy should be able to sustain the US until it stabilizes, not to mention the fact that there is always the possibility of interest rates being cut.

The collapse of some major American hedge funds on the back of the subprime mortgage crisis has caused some anxiety for banks. Banks are finding it increasingly difficult to sell off debt. This illiquidity and heavy reliance on hedge funds is also another issue to be addressed by banks. At a time where many are suggesting that brokers impose harsher lending practices, it might not be in the banks’ best interest to do so. Lending to hedge funds is necessary in order to ensure that investors are capable of purchasing debt. Despite the many challenges that lie ahead for those in lending institutions, the credit squeeze may serve to simply cool down overheating stock markets and stabilize the overall market environment. It is early days yet, and it remains to be seen whether or not this credit squeeze intensifies or if the global economy is strong enough to cope with it.

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