Nov. 21 (Bloomberg) -- Top-rated commercial-mortgage bonds tumbled 24 percent in November, almost triple the worst month ever, as Treasury Secretary Henry Paulson reversed a decision to buy mortgage assets to help stabilize the credit markets.

Investor confidence slumped after Paulson said on Nov. 12 the U.S. won’t make the purchases a focus of the government’s $700 billion rescue program.

“Paulson’s waffling caused prices to fall off a cliff,” said Mitchell Stapley, who oversees about $22 billion as chief fixed-income officer at Fifth Third Asset Management in Grand Rapids, Michigan.

Paulson’s program has focused on propping up banks and the real estate market through asset purchases; on making equity injections into financial companies; and on supporting consumer lending such as auto and student loans. On Nov. 18 Paulson told lawmakers he has no plans to use half of the money allotted by Congress, indicating it will be up to the incoming Obama administration to resolve the matter.

“People expected this $700 billion of buying to emerge, and when it didn’t the market just completely collapsed,” said Sean Kirk, a trader of structured-finance bonds at New York-based Seaport Group LLC.

Top-rated commercial-mortgage bonds, the largest part of the $800 billion market, lost almost 24 percent this month through yesterday, according to Merrill Lynch & Co.’s CMBS Fixed-Rate AAA-Rated index. The tumble compares with an 8.5 percent drop in October, the previous worst since at least 1998.

Living in Boxes

One of the AAA classes of a $7.6 billion 2007 deal from Goldman Sachs Group Inc. considered a market benchmark fell yesterday to about 53 cents on the dollar, according to RBS Greenwich Capital.

At current prices, all the loans could default within 18 months and a buyer wouldn’t lose money, according to Lisa Pendergast, an analyst at the Greenwich, Connecticut-based unit of Royal Bank of Scotland Plc. That’s assuming foreclosure recoveries of 37 percent, compared with the typical 60 percent.

“The default levels implied by where these bonds are trading mean we will all be living in boxes,” said Eric Johnson, president of 40/86 Advisors Inc. in Carmel, Indiana.

Falling commercial-mortgage bonds have in turn contributed to yield spreads on investment-grade corporate bonds climbing to a record and prices for high-yield corporate loans falling near all-time lows set last month. The declines also helped send the stocks of banks and insurers including MetLife Inc. and Hartford Financial Services Group into their own tailspin.

Insurer Stocks

The Standard and Poor’s Supercomposite Life & Health Insurance Index of insurer stocks fell 45 percent this month through yesterday, while spreads on investment-grade bonds yesterday climbed 16 basis points to 622 basis points, according to Merrill’s U.S. Corporate Master index.

While the commercial-mortgage slump intensified as concern rightly grew that loan defaults may soar amid data showing a worsening recession and reports about $334 million of problem loans bundled into bonds this year, the slide may more reflect buyers either running out of money or avoiding purchases before prices stabilize, Jim Shallcross, director of portfolio management at Declaration Management & Research LLC, said.

“There’s nobody with a ton of capital they’re committing right now,” Shallcross said yesterday. His McLean, Virginia- based firm manages about $14 billion in fixed-income assets.

Dealers Step Away

Sellers of AAA commercial-mortgage securities, one of the few structure-finance categories to remain relatively liquid amid market turmoil, have included funds facing investor redemptions and insurers, Seaport’s Kirk said.

Liquidity is now being hurt by “several dealers stepping back from the CMBS market,” with probably less than $3 billion being used to make markets, Citigroup Inc. analyst Darrell Wheeler wrote in a report today. “While two weeks ago five or six dealers were actively quoting cash CMBS positions, in the middle of last week two dealers seemed to have pulled back.”

Commercial-mortgage bonds yesterday suffered their worst day ever. Yields on the safest category of AAA rated commercial- mortgage bonds rose 3.34 percentage points to a record 15.29 percentage points more than interest-rate swaps, according to Bank of America Corp. data.

The spread, which entered this year at 0.82 percentage point, has climbed from 6.43 percentage points on Nov. 10, the last trading day before Paulson’s announcement.

Credit Default Swaps

The cost to protect against defaults on top-rated commercial-mortgage bonds today declined from a record, suggesting losses on the bonds may narrow.

Credit-default swaps on the bonds fell 140 basis points to 725 basis points based on the latest Markit CMBX index contracts as of 12:53 p.m. in New York, according to a note to clients from Goldman Sachs Group Inc. That means it would cost $755,000 in annual premiums to protect $10 million of the debt.

Some investors and analysts blame the bond drops on hedge funds and banks using CMBX indexes to bet against the debt because they know buyers are scarce.

“There is evidence that short-sellers are targeting this market because they know they can push it around,” said James Grady, managing director in New York at Deutsche Asset Management, which has about $240 billion of fixed-income assets under management.

“Recent speculative conditions reminds us of the summer when oil was $140 a barrel, and many parties were calling for $200,” Wheeler wrote. “Commercial real estate conditions are deteriorating, but we cannot justify recently cheap levels.”

Concern about the quality of commercial mortgage debt “runs the risk of creating a self-fulfilling prophecy: If borrowers can’t get capital at reasonable levels, this potentially leads to defaults when debt needs to be refinanced,” Grady said.

To contact the reporters on this story: Jody Shenn in New York at jshenn@bloomberg.net; Sarah Mulholland in New York at smulholland3@bloomberg.net

Last Updated: November 21, 2008 15:10 EST