‘Riot in the Casino’ This Week?

That the was the forecast of former Reagan Administration budget official David Stockman, referring to the Federal Reserve’s apparent intention to raise interest rates — for the first time in 10 years — in the teeth of an accelerating junk-debt and commodity price collapse.

Junk debt (junk bonds and leveraged loans) in the U.S. economy, as a reminder, totals at least $2 trillion in “assets” mainly held by banks, although many mutual, pension, and hedge funds are also involved. The junk-debt market decline has become very sharp in December, with interest rates on middling (CCC-rated) junk bonds hitting 17.25% Dec. 10 and shooting upwards. This debt is essentially impossible to refinance. In recent weeks the ratings agencies and banks have charted a “spike” in defaults and bankruptcies of junk debtors — concentrated in oil and gas exploration and related services — and warned the “spike” will become a “wave” in January-February.

Now, two junk creditors have gone under. Two debt-invested funds have liquidated in the past few days. The first was actually a mutual fund: the $1.8 billion, “well-respected” Third Avenue Capital on Dec. 10. Its founder Martin Whitman is designated a “legendary vulture investor.” Just as that was being explained away (“it was investing in unrated debt”), the second went under on Dec. 11. It was Stone Lion Capital, a $2 billion hedge fund which was one of those investing in Puerto Rico distressed debt.

Some see a “Bear Stearns moment” — i.e., the bankruptcy of the two CLO-invested hedge funds in June 2007, which exposed the “non-containment” of the mortgage securities/derivatives meltdown. Vulture investor Carl Icahn gave a “keg of dynamite” interview on CNBC, saying “I believe the meltdown in High Yield is just beginning.”

The Wall Street Journal wrote Dec. 11, “The move is also a sign of how much the market for [all —ed.] corporate debt is deteriorating. “‘Investors have been dazzled that yields on bonds have climbed so high, even while default rates remained low,’ said … a longtime junk-bond analyst. ‘Currently, though, the ability to sell a large position is especially poor. When that tension gets especially high, you can see something snap.'”

The century-old British colonial looter Anglo American, which was making “energy-junk” loans on a large scale, is suddenly at the brink of junk itself, with Moody’s downgrading it Saturday to one step above junk for all its divisions and placing a negative advisory on all of them. Credit default spreads on both Anglo American and Glencore rate them at more than a 50% chance of default, requiring $1,000 cash up front to insure $10,000 of their debt.