Posted on 11/05/2007 6:17:03 AM PST by Diana in Wisconsin
When Merrill Lynch, the US bank, announced 10 days ago that it was taking $8bn-worth of losses on mortgage-related securities, bankers and regulators around the world reeled in shock. For the writedown was twice the size of the losses that Merrill had forecast just a two and a half weeks earlier - a "staggering" multi-billion dollar gap, as Standard and Poor's, the US credit rating agency, observed.
But last week, investors received an even more staggering set of numbers. As financial analysts perused Merrill's results, some came to the conclusion that the US bank could be forced to make $4bn more write-offs in the coming months.
These calculations were not limited to Merrill: after UBS (NYSE:UBS) unveiled $3.4bn (EU2.3bn, £1.6bn) of third-quarter mortgage-related losses last week, Merrill Lynch analysts warned that the Swiss bank would need to take up to $8bn more losses in the fourth quarter of this year. Meanwhile, Citigroup (NYSE:C)'s share price slumped on rumours that it may need to acknowledge another $10bn of losses.
Such a tsunami of red ink would undoubtedly be shocking at any time. But right now, this news is proving particularly unsettling for investors for two particular reasons. First, the numbers offer an unpleasant reminder that the pain from this summer's credit turmoil is still far from over - contrary to what some bullish American bankers and policymakers were trying to claim a few weeks ago. "To judge from secondary market prices, losses on mortgage inventory are likely to be larger in the fourth quarter than the third quarter," warns Tim Bond, analyst at Barclays Capital, the UK bank.
Second, the write-downs have reminded investors just how little is known about where the bodies from this summer's credit turmoil might lie. Perhaps the most shocking thing about recent announcements is that while big banks might have now written down their mortgage holdings by more than $20bn, this does not appear to capture all the potential losses.
Last week, for example, a US congressional committee warned that over the next year mortgage lenders could foreclose on 2m American homes, destroying $100bn of housing value. And some private sector economists think the total loss from mortgage problems could reach $200bn or more. "What everyone keeps asking is where are those losses sitting - where is the rest of that $100bn?" admitted one senior international policymaker late last month. "The worrying thing is that there still is just so much uncertainty around."
To an extent, this uncertainty reflects the fact that the tangible scale of defaults in the US mortgage arena is still unclear, particularly in that sector of the mortgage market known as "subprime" - loans extended to borrowers with poor credit histories. In the past year, the pace of defaults on subprime loans has risen sharply in America, particularly on mortgages made in 2006 and 2007. However, it is unclear what scale of losses this will eventually produce for banks, since it typically takes several months for lenders to foreclose on loans and then sell a property.
Moreover, it is also very unclear how the pattern of mortgage defaults will develop. While some economists fear that the default ratios could rise sharply in the coming year, others suspect that the US government will force lenders to be lenient towards borrowers. Thus estimates of potential mortgage losses in the subprime sector range from $100bn (according to government figures) to several times that.
However, when it comes to working out the impact on banks, the task becomes even harder. For in recent years, banks have not simply been acquiring subprime loans, they have been repackaging them into complex "asset-backed securities" (ABS) that can be difficult to value. The Bank of England, for example, suggests that on the basis of industry data some $700bn-worth of bonds backed by subprime loans are now in circulation in the world's financial system, with another $600bn of bonds backed by so-called "Alt A" loans, or those with slightly better credit quality.
Moreover, these bonds have then been used to create even more complex securities backed by diversified pools of debt, known as collateralised debt obligations (CDOs). According to the Bank's calculations, for example, some $390bn of CDOs containing a proportion of mortgage debt were issued last year - though the precise level of the subprime component varies.
The multi-layered nature of these complex financial flows means it is hard to assess how defaults by homeowners will affect the value of related securities.
In recent weeks, some credit rating agencies have indeed started to downgrade their ratings of debt: Moody's and S&P, for example, downgraded about $100bn of mortgage-related securities last month. But most analysts think that this "downgrade" process is still at a very early stage - and in tangible terms, that means that subprime defaults have not yet delivered tangible losses for many security investors. "Most CDOs have yet to see many downgrades and there have been almost no actual defaults of the ABS bonds within the CDO portfolios," points out Matt King, analyst at Citigroup. "[But] all that is about to change."
The other big problem that makes it hard to calculate the "real" scale of mortgage-linked losses at banks is that it is often fiendishly hard to get an accurate value for mortgage-linked assets - and thus determine how much prices have fallen so far. In other arenas of finance, such as equities, banks typically value their assets by looking at external markets: the share price of a British company, say, can be calculated within seconds, by glancing at the stock exchange. Mortgage-related securities have not been widely traded in recent years, and in the past couple of months activity has dried up almost completely - meaning there is no market, and thus no market value.
Some banks have tried to get around this problem in the past by developing computer models to work out what the securities "should" be worth. However, these can be very unreliable and vary wildly between different banks. Recent calculations by the Bank of England, for example, show that if tiny changes are made to the type of model typically used by banks to value mortgage-linked debt, the implied price of supposedly "safe" assets can suddenly change by as much as 35 per cent.
As a result, some analysts are now using another technique to work out their mortgage-linked losses, namely, extrapolating from prices based on derivatives indices such as the so-called ABX. For although mortgage bonds have not traded much in recent weeks, derivatives have been bought and sold - meaning that the ABX can offer a trading price.
In recent weeks, this trading price has fallen sharply (see chart), which has increased the pressure on banks to mark their books down. However, the banks have not yet made write-offs as large as the ABX might imply. Merrill Lynch analysts, for example, calculate that mid-quality ABX debt is on average now trading at 40 cents in the dollar. But these analysts say that Merrill Lynch itself has only written this type of debt down to 63 cents in the dollar - and UBS is still assuming this debt is worth 90 cents. "Simple math would imply that UBS needs an additional $8bn write-down [on its $15.4bn holdings] if the ABX pricing is correct," Merrill says.
But the problem is that no one really knows whether these numbers represent the "true" guide to tangible mortgage losses either; some analysts claim, for example, that the ABX is an unreliable guide to price. Moreover, most banks have not actually sold their troubled securities yet in an open market. And while there are reports that some banks have tried to arrange quasi-sales between institutions, on "sweetheart" terms in recent months, the US regulators now appear to be scrutinising these practices too - not least because this could potentially manipulate prices as well.
But if these problems make it hard to calculate the scale of banks' subprime losses, the guesswork becomes even wilder when it comes to other financial groups. As the subprime credit chain has grown in recent years, it has left banks exposed not simply to these assets but to a host of other investment institutions as well, including insurance companies, pension funds and hedge funds. These institutions sometimes use different approaches to reporting their subprime exposures from those adopted by bulge-bracket banks - and these differences are further magnified by the fact that they are operating under different national accounting regimes.
In some corners of the global financial system, institutions are already trying to come clean about the pain. It is relatively easy, for example, to calculate the losses at so-called structured investment vehicles (SIVs) - a breed of specialist fund - because they are required to publish regular "net asset value" numbers. According to the rating agencies, for example, the average value of assets in SIV vehicles has fallen by a third since the start of the summer.
Some investors with holdings of SIVs have recently come clean about their losses. TPG-Axon, the US hedge fund, is understood to have written off the value of all the junior notes issued by its SIV.
A number of Taiwanese banks - which have been among the biggest buyers of such paper - have also been surprisingly frank. For example, Bank SinoPacsaid it would take a third-quarter hit of $43m on its $350m of SIV holdings.
However, for every example of transparency there is a case - or several - of an institution reluctant to reveal losses. In jurisdictions such as Japan, for example, it is widely accepted that institutions need not mark all their assets to market, since they often hold these to maturity.
Similarly, uncertainty dogs large parts of the asset management world in continental Europe. Meanwhile, the insurance industry is generating particular anxiety among some investors. In recent days, for example, the share price of the largest US monoline insurance groups, such as MBIA (NYSE:MBI) and Ambac, have collapsed in spectacular fashion due to concerns about potential exposure to mortgage-linked CDOs. The two companies say that they do not have any serious problems - and point out that the proportion of mortgage-related assets in their business is tiny. But the challenge that dogs these "monoline" groups is that their balance sheet accounting is poorly understood by most investors.
Optimists within the financial world point out that such uncertainty is not unique to the 2007 credit squeeze: 15 years ago, for example, the financial world was presented with a similar fog, when it tried to untangle the losses that hit the Lloyd's insurance syndicate. "There are a lot of parallels today," says Adam Ridley, a senior London financier who was heavily involved in the Lloyd's affair.
However, the challenge for policymakers today is that the 2007 credit storm - unlike the Lloyd's debacle - is not a contained affair: on the contrary, the opaque subprime chain has created unexpected linkages between an extraordinarily wide range of investors and institutions around the world. The longer investors continue to fear that this chain could produce unexpectedly large future losses, the greater the danger of a downward spiral in investor confidence - and thus the higher the risk of a knock-on impact on the "real" economy.
However, forewarned is forearmed. :)
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There’s a thing called “kitchen sinking” that was mentioned here on FR the other day.
These banks are writing off ALL subprime debt...even though most of these notes will be paid satisfactorily and will not be losses. There are several reasons for this...but what it means is that later on...when this does shake out they will show larger profits at that time than they otherwise would have.
I would expect to see THE SKY IS FALLING articles posted at lefty sites, not here.
Surprise surprise.
The truth hurts.
To put things in perspective - the ENTIRE S&L cost was 150 billion dollars (in 1988 or $256 billion in 2006). And this, IMHO, this is still the tip of the iceberg for losses...
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If people would ONLY realize that shouldn’t live beyond their means with mortgages and credit cards this wouldn’t be happening. There will ALWAYS be people out there, in this case mortgage companies and credit card companies looking to exploit you. Looks like greed isn’t paying off for either. The government needs to STAY OUT OF THIS. There is a lesson to be learned here.
I'm still kind of surprised that the bond rating companies like Moody's and Standard & Poor's haven't been completely discredited as a result of this whole mess (since most of these CMOs filled with bad loans were rated as investment-grade bonds by those morons).
‘zackly. S&P blessed the subprime mortgage bundling. Their acts encouraged this mess.
$200 billion when averaged into the an economy the size of the US's, won't cause the great depression.
2,000,000 homes averaging even a whopping $250,000 in debt each and overvalued and underwater by 25% is still only $125 billion - a fly speck in the big picture - but what the heck - reports like this sell newspapers..........
Sounds like 2,000,000 NEW homeowners are going to get a good buy on a home at the expense of 2,000,000 that made mistakes.
Sucks donit.....
In this article you will fail to find the words “illegal” or “immigrant”. The 800 pound gorilla again goes unnoticed.
Here is a reposting from last March. It is still unrefuted and unreported. Can’t upset the conventional wisdom, can we?
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To: Freedumb
Gotta hand it to the MSM, the WSJ, the Chamber of Commerce, the Fed, the banks, the White House, the Congress, Fortune, Kudlow, and all the rest of the usual suspects.
These subprime mortgages go to someone. They have a mailing address. By artful writing and punditry, the picture has been painted that the people who got these subprime loans are poor folks or dumb boomers who re-financed to buy their new Volvo and swimming pool. Wrong!
Those cases are few. Those subprime mortgages issued in the last several years that are now facing foreclosure have gone to illegal aliens, landlords who rent to illegal aliens, and minorities who have lost jobs to illegal aliens, especially African-Americans in the trades and services industries. The common thread - illegal aliens. Spend 10 minutes on Google and you can see the aggressive marketing of subprimes to illegals (you may have to translate).
The distribution of subprimes going into foreclosure closely matches the concentrations of illegal aliens - California, the southwest border states, the southeast states, metro areas like Denver and in the Rust Belt. Many of these mortgages were granted to buyers with no SS number or a stolen number or just a taxpayer ID number (ITIN). Who is that group? Not blacks; not boomers. Not even speculators. Who’s left? You figure.
Some common scenarios: An illegal, actively recruited by banks or mortgage lenders, buys a house, often an expensive house ($600,000). If he can’t qualify, he gets other illegals added to the mortgage until they qualify. Or a profiteering landlord buys a house with the intent of setting up a dorm house for illegals. With 10-20 illegals crowded in at $300-400 rent, he makes a tidy profit even with a big mortgage payment.
Like Ponzi, it was great for everybody. The banks made big profits on the high interest. So did the REIT and funds managers. The landlods did well also on rents and house appreciation.
Then the housing bubble burst. The illegal renters started losing work and were evicted. The landlords couldn’t service the mortgage and/or with lowering values the mortgages went upside down so it was easy to walk away and foreclose.
But that’s not the big story. It’s how effective the cabal of power brokers from the White House, the Chamber of Commerce, the MSM, the Congress, the banks, the CEOs, and the unions have covered up this causality so that they can get amnesty and open borders rammed through to guarantee an unending supply of cheap alien labor.
They know that if the connection between illegal alien hordes and the subprime collapse and the damage to the economy worse than the Savings & Loan scandal of the 1980’s, the people will be outraged and demand we close the borders.
Can’t have that. Let’s keep the sheeple in the dark. They’ll be the suckers paying for it in the end with lost jobs and higher taxes. The real villians have already made their fortunes.
8 posted on 03/23/2007 9:11:29 AM PDT by oldbill
Your comment of the $250 billion in bad debt is based upon the selling price of the structures, I would hope you would take a look too at all the other sectors involved with job losses and stock earnings and price pull backs for....banking, construction, building materials, trucking, real estate agents, mortgage lenders. I've read and have to agree with a another couple of articles in that the net effect loss will be in the 2.9-3.2 trillion dollar range (USD) in just the US alone. Don't forget, this fiasco is going to affect global credit markets.....inflation, here, is on the way big time.
Great point. I love alarmist clap-trap. It creates opportunities to those who buy in during the panic-response, knowing things will shoot right back up a few days later. And the TV hairstyles, I mean perky analysts, will note with amazement that the market "shrugged off" the piece of bad news they were selling as a catastrophe the day before.
Uh, a loss like that ($3 trillion) would be just $30,000 per HOUSEHOLD in America. Sneezing money.
Now my house may very well go down $30,000 (or more!) but, what the heck, it has gone from $100,000 to $750,000 in the 30 years I have owned it.
You are obviously surprised that I am not bothered by that......and since I don’t owe a dime on it, like millions of other Americans, big deal!
Stop with the sky is falling rhetoric.
The losses are trivial. The real damage is the slowing down of the flow of money...the credit crunch...which was exacerbated by a slow Fed (because they wanted to pop the housing bubble).
But the S&L crisis of the 1980's was $256 Billion in today's Dollars against a $6 Trillion economy...whereas the 2007 subprime crisis will peak at $200 Billion against a $12 Trillion economy.
The sub-prime mess will be a drop in the bucket compared to the S&L crisis and dot.com / NASDAQ implosion.
The losses for the housing bubble/fraud/greed is going to approach $1 Trillion...it is going to make the S&L mess look like a Sunday picnic.
Uh, increases in the valuation of our homes has never been a part of our GDP, which is a measurement of the goods and services PRODUCED by us.
Good lord. Try fathoming the total valuation of all homes, businesses, structures, infrastructures in this country!
The sum is HUGE!
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