Contagion

In the news this week, the unsurprising discovery that there is an element of social contagion in obesity. If your friends and spouse eat a lot, you likely will too, taking your cue from them. Who wants to be the only one at the table eating just a stick of celery?

There's another common use of the word "contagion" these days. It's financial. The problems in the subprime housing market -- are they contained or are they contagious? Will the rest of the economy (of the US? or the industrialized world?) catch the subprime flu? Has it already?

Bill Gross, a bond guru with Pacific Investment Management Co (Pimco) certainly believes in contagion. In some of his recent writings, he seems almost to welcome it.

"Borrowers and lenders may have bitten off more than they can chew, and even those that swallow their hot dogs whole – Nathan’s Famous Coney Island style – are having a serious bout of indigestion," he wrote in a recent commentary. "Several hundred billion dollars of bank loans and high yield debt wait in the wings to take out the private equity and leveraged buyout deals that have helped propel stocks to Dow 14,000. And lenders…mmmmm, how do we say this…don’t seem to have much of an appetite anymore. Six weeks ago the high yield debt market was humming the Campbell’s soup theme and now, it’s begging for a truckload of Rolaids."

For more, go here: http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+August+2007.htm

I certainly don't share Mr. Gross' apparently its-about-time attitude there. But I worry that he may be right, that Dow 14,000 may represent a peak, and that we may be in for a very bumpy road on the way down.

The business cycle has always been, at its heart, a credit cycle. This time around, at this peak, that "heart" is a bit nearer the surface of the skin than is usually the case.