Window Dressing Turns Toxic on Wall Street: Lisa Abramowicz

Big banks always like to tidy up their balance sheets ahead of their quarterly earnings reports, the Wall Street equivalent of putting on makeup before a big date. But the latest go-round was more than a vanity exercise for the debt market, and more ominous, it could turn garish at the end of the year.

The banks were especially aggressive about primping and pruning at the end of September. Dealers sold a net $5.6 billion in just one week, leaving them with the smallest pool of corporate-debt holdings on their books in recent history. The 22 primary dealers that trade with the Federal Reserve reported just $13.1 billion of the debt at the end of last month, 71 percent below the amount in March 2014, according to Fed data compiled by Scott Buchta at Brean Capital LLC.

The scrubbing exercise may seem innocuous enough, at least on the surface. After all, banks are truly pushing risk off their books. Their exposure went from minuscule to even less relative to the $8 trillion U.S. company-debt market. 

But the banks’ quarterly cleanup came at a terrible time for markets. The Fed, once a reliable support for speculative-grade assets, is preparing to take away its punch bowl. Global growth is slowing. Oil prices are still persistently lower than many companies can handle.

Given that backdrop, Wall Street’s end-of-September purge was exacerbated by even more selling by asset managers. In that one week alone, riskier corporate bonds in the U.S. lost about 2 percent, while more-creditworthy ones declined 0.2 percent. Average yields on corporate bonds globally surged to 3.9 percent on Sept. 30, the highest in about two years.

Banks almost certainly took losses in the exodus, given the dismal week for returns. And their selling only intensified the anxiety of fund managers, who are then forced to compete with them to sell their holdings faster and at better prices when sentiment deteriorates.

Wall Street is foreshadowing a potentially troubling December, when trading volumes typically fall and funds traditionally take chips off the table heading into the New Year. Another bout of extended selling would most likely roil markets even more.

While banks may be saving themselves a few bucks in capital charges by engaging in this practice, they risk inflicting even deeper pain on the rest of the market. It may be pretty for their investors; it could turn ugly for everyone else.

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