Credit contagion
Is the worst over? Fortunes Peter Gumbel offers a
10-point guide to understanding two harrowing weeks - and whats likely to
happen next.
FORTUNE Magazine
By Peter Gumbel, Fortune
August 14 2007:
10:36 AM EDT
PARIS
(Fortune) -- Relax! Theres really no need to panic! Thats the soothing
message being put out this week by key players in financial markets after two
harrowing weeks in which credit markets in Europe all
but dried up, prompting massive injections of funds into the system by the
European Central Bank, the U.S. Federal Reserve and the Bank of Japan.
Overnight borrowing rates have come back down after
spiking wildly and stock and bond markets have been bouncing back around the
world. The European Central Bank, which continued to inject funds into the
market on Tuesday, albeit less than one-tenth the amount at the peak of the
crisis last week, says that money-market conditions are normalizing. And Tuen
Draaisma, Morgan Stanleys chief European equity strategist, for one,
recommended
in a note to clients that they should go overweight in equities because we
may already be at the point of maximum bearishness and uncertainty, which by
definition is the right moment to buy.
So is the worst over? Even the most die-hard optimists concede
that itll take a lot more than a few days of calm to restore confidence among
financial institutions and retail investors. The market is concerned pretty
much across the board, says Gerry Rawcliffe, a managing director in the
banking group at Fitch Ratings in London.
Heres a 10-point guide to what we know and dont know
about the troubles, and what the repercussions are likely to be:
(1) Why
did Americas
subprime mortgage woes have such a big impact on world financial markets?
Because these mortgages were lumped together in packages
and sold as asset-backed securities all over the world, particularly in Europe.
Often the initial securities were themselves put into new packages, leveraged
up and resold as so-called collateralized debt obligations (CDOs). They
are a sort of derivative play on the underlying mortgages, just as futures and
options are a play on stocks and commodities. Big banks have whole
securitization departments who create these instruments. They do so to profit
from the difference between the long-term returns these investment vehicles
produce and their more plain vanilla short-term borrowing, and to earn fees.
(2) Who bought them?
Everyone, and thats the problem. The CDO market has
exploded in recent years: More than $100 billion worth of structured cash CDOs
were issued in the fourth quarter of last year alone, according to CreditFlux
Data+, a London firm that tracks
them (and that doesnt include the even more arcane synthetic CDOs). Banks,
institutional investors and hedge funds have been the main customers, but some
retail investors have also bought into them through the asset-backed
securities, or ABS, funds that some of the biggest European banks sell to the
public. Everyone who bought these securities was given the same pitch, namely
that they were a relatively safe bet, since much of the paper had AAA ratings,
but offered higher returns than regular corporate bonds.
(3) So what went wrong?
The number of delinquencies in the U.S. subprime mortgage
market has been rising and is now substantially larger than anyone expected -
about 14 percent of the total, up from about 10 percent in 2004 and 2005. That
means theres a strong likelihood that some of the securities holders,
especially those where the underlying mortgages were taken out in the past
couple of years, are sitting on losses.
Those troubles have been massively compounded by the
aggressive use of leverage in CDO packages. When U.S.
blue chip financial players like Bear Stearns and then a variety of European
banks began reporting problems, panic quickly gripped the markets. That turned
into a vicious circle: These debt instruments have now become impossible to
price because nobody wants to buy them any longer. And since they cant be
priced, the size of the losses arent clear, which in turn has given rise to
more rumors about financial players in trouble. Banks in continental Europe
especially simply stopped lending to one another, which is why the liquidity
dried up in the credit markets as a whole and the European Central Bank had to
jump in.
(4) How big is the problem, really?
Nobody is quite sure. Patrick Artus, an economist at
Natixis in Paris, reckons the total
damage inflicted by subprime woes is a relatively manageable $45 billion, which
is the difference between the expected rate of mortgage delinquencies and the
current much higher rate. Another French bank that is an important player in
the derivatives market, Sociéte Générale, reckons that even if things really
turn sour, the worst will be losses of about $100 billion. That may sound like
a lot, but its the equivalent of about 1 percent of the total market
capitalization of the S&P 500.
Such calculations highlight the real issue here, that the
panic has been due more to a collapse of confidence than to any financial
cataclysm. Were still primarily looking at a liquidity crisis rather than a
credit or a solvency crisis, says Fitchs Rawcliffe.
(5) Is it really over?
No. The market remains very, very fragile, says a top
executive at one of the leading European banks. Some confidence has been
restored into the international banking system and its overnight lending
patterns by the big injections of central-bank funds, but nobody has yet dared
to start buying that subprime paper in any sizeable quantities. And because
theres so little transparency about who is sitting on what size losses, the
rumors continue to swirl.
Nouriel Roubini, an economics professor at New
York Universitys
Stern School of Business, who has long warned about the risk of financial
contagion, reckons some other parts of the U.S.
housing market including home equity loans and second mortgages are starting to
display what he calls the same toxic characteristics as the subprime sector.
More optimistically, Neil McLeish, the chief European credit strategist at
Morgan Stanley, says that, we have passed the absolute peak of that anxiety
and uncertainty. But even he believes that credit market conditions will be
more difficult in the coming months and, there is still some risk of
additional volatility at least for the next month or so.
(6) Who are the biggest casualties?
Banks and financial market players across the world are
starting to come clean about their exposure and losses, partly in order to help
restore confidence in the market. The losses incurred by Wall Street titans
Bear Stearns (Charts, Fortune 500) and Goldman Sachs (Charts, Fortune 500),
which this week announced it is putting $2 billion into one of its hedge funds,
have received the most publicity. Outside the United
States, firms such as insurer AXA (Charts)
and BNP Paribas in France
have frozen or shut problem funds, while a range of banks including NIBC of the
Netherlands and
Commerzbank in Germany
have detailed their exposure and expected losses.
The biggest international victim to date is a mid-sized
German bank called IKB Deutsche Industriebank that its peers, including a
government-owned bank, stepped in to rescue earlier this month, taking over $11
billion of credit lines and putting up a $4.7 billion funding package. IKB had
been an aggressive player in the CDO market, through two off-balance sheet
firms that it used to pump up its commission income and advisory fees. In the
end, its exposure to dodgy securities through these two firms far exceeded the
banks liquidity and equity capital.
(7) Is anyone safe?
Not completely, but barring some huge problem nobody yet
knows about, major banks seem in the best position to weather this storm
because they have the strongest balance sheets and are able to refinance their
operations most easily thanks to the extra liquidity that central banks have
put into the market in the past week. Being a bank and having access to the
central bank (credit) windows is key at the moment, says the top European
banker.
Hedge funds are another story, as the Goldman Sachs-run
one that was bailed out this week shows, although some of these funds foresaw
the troubles and have been aggressively shorting the subprime sector and any
securities relating to it.
(8) Why didnt central banks cut interest rates in
response?
Some critics of the European Central Bank, especially in France,
are saying that its interest rate policy, which has consisted of regular rate
hikes to counteract inflation, has partly fueled this crisis. One can ask if
the ECB isnt becoming a prisoner of its rate-increase strategy, Thierry
Breton, the former French finance minister said this week. But bank economists
are generally more supportive and say that the ECB acted smartly with its three
consecutive days of huge money-market interventions - the biggest of which was
a whopping $130 billion injection last Thursday. Its a demonstration of the
financial system operating as it should, said James Nixon, a London-based
economist at Frances
Société Générale, who says that the troubles primarily affect the financial
sector rather than the wider economy.
While the Fed did cut rates in 1998 during the last
derivatives meltdown, involving Long Term Capital Management, central banks may
not need to this time if markets continue to calm down. Indeed, the big
question now is whether the ECB and the Bank of Japan will go ahead and raise
rates in the next month, as they had signaled before the crisis. Roubini isnt
sure, and thinks that the Fed may well move to reduce U.S.
rates quite soon. The likelihood of a cut in rates is now much higher, he
says.
(9) What does this mean for the world economy?
So far, not all that much - but keep your fingers crossed.
Growth in Europe and Asia remains
buoyant, even if the U.S.
outlook is unclear. Some borrowing by companies and individuals is bound to get
more expensive as markets adjust and restore a risk premium. But its not
obvious that the repricing will lead to an economic slowdown, says Société
Générales Nixon, although theres a possibility that Britains
economy, which has thrived because of its heavy dependence on financial
services, may be vulnerable. Roubini thinks the United
States will bear the brunt of what he sees
as an inevitable slowdown of consumer spending related to the housing woes, and
reckons that this could ultimately spill over to the global economy if its
sufficiently severe. The effect on the real economy in the rest of the world
depends on whether theres a hard landing in the U.S.
he says.
(10) Will there be any regulatory fall out?
This is almost inevitable, especially in Europe
where its now clear that many of the purchasers of these securities didnt
fully appreciate the risks they were taking. Look for the first moves to come
in Germany,
where bank bail-outs are exceedingly rare. The last time a bank got into
serious trouble there was in 1974, when the Herstatt Bank collapsed after some
disastrous forays into foreign-exchange trading that bear some similarity to
IKBs woes. Regulators quickly followed up with an overhaul of the national
banking system. Its not clear that IKBs rescue will have the same dramatic
repercussions, but its already prompting tough questions about how a mid-sized
bank could end up with such an enormous exposure to risky assets via an
off-balance-sheet firm.
I suspect that at the end of this, regulators will ask
themselves if this very rapid expansion (of transactions involving asset-backed
securities) has been a good thing for banks, or if the risk comes back to haunt
you, says Fitchs Rawcliffe. Watch also for credit agencies to come under
pressure to do a better job at assessing the market risk of exotic financial
instruments.
____________________________________________________________________________________Ready
for the edge of your seat?
Check out tonight's top picks on Yahoo! TV.
http://tv.yahoo.com/
[Non-text portions of this message have been removed]
=========================
Arsip Milis AKI online, demi kenyamanan Anda semua
http://www.mail-archive.com/[email protected]/
-------------------------
Ingin improve kemampuan English Anda? Atau berbagi dgn berinteraksi atau
mengkoreksi English dgn sesama? Join for free lifelong english lesson di
sharing_english_lesson-subscribe@@yahoogroups.com
-------------------------
Yahoo! Groups Links
<*> To visit your group on the web, go to:
http://groups.yahoo.com/group/AhliKeuangan-Indonesia/
<*> Your email settings:
Individual Email | Traditional
<*> To change settings online go to:
http://groups.yahoo.com/group/AhliKeuangan-Indonesia/join
(Yahoo! ID required)
<*> To change settings via email:
mailto:[EMAIL PROTECTED]
mailto:[EMAIL PROTECTED]
<*> To unsubscribe from this group, send an email to:
[EMAIL PROTECTED]
<*> Your use of Yahoo! Groups is subject to:
http://docs.yahoo.com/info/terms/
