Low-risk debt moved into a high-risk neighborhood Tuesday, taking major averages along for the descent.
Financial institutions and money market funds that are exposed to so-called low risk, short-term debt that's collateralized by mortgage-backed securities may be in jeopardy.
So far, the problems with short-term debt, called asset-backed commercial paper, are reportedly limited to Sentinel Management Group, an Illinois-based money management firm, and Coventree, a Canadian company that organizes commercial paper sales for companies seeking the short-term financing.
But the potential for contagion has increased amid fears that short-term financing obstacles could lead to further drying up of liquidity across the board."This really turns it up a notch in terms of systemic risk," says Christian Stracke, analyst at CreditSights, an independent fixed-income research firm. In reaction, the Dow Jones Industrial Average fell 208 points, or 1.6% to close at 13,028.92 while the S&P 500 fell 1.8% to close at 1426.56 and the Nasdaq Composite declined 1.7% to close at 2499.12. (Risk of additional declines Wednesday accelerated after the close as Applied Materials (AMAT - Get Report) issued cautious comments about its fiscal fourth quarter.) The CBOE Volatility index, or VIX, which is an indicator of fear, ended near its highs for the day, up 4.7% at 27.83. The Amex Securities Broker Dealer Index slid 3.1% amid more losses for big brokers, including Lehman Brothers (LEH)and Goldman Sachs (GS - Get Report). The stock and credit markets have been extremely volatile since the subprime mortgage market sparked a correction in riskier debt assets. Mystery surrounding the valuation of derivatives called collateralized debt obligations has also led to liquidity drying up, a scenario so real that it recently required extra liquidity injections from central banks around the world.