Friday, November 02, 2007
credit market pressure mounting
Take the ABX index, the basket of derivatives linked to subprime securities. As financial tools go, this index is far from perfect, since it is barely two years old, and tends to be thinly traded.
But right now it has the unfortunate distinction of being the only tool easily available to measure sentiment in the opaque subprime securities world. And in the past couple of weeks, the message emerging from this measure has started to look utterly dire.
Never mind the fact that the risky tranches of subprime-linked debt (the so-called BBB ABX series) have fallen 80 per cent since the start of the year; in a sense, such declines are only natural for risky assets in a credit storm.
Instead, what is really alarming is that the assets which were supposed to be ultra-safe – namely AAA and AA rated tranches of debt – have collapsed in value by 20 per cent and 50 per cent odd respectively.
This is dangerous, given that financial institutions of all stripes have been merrily leveraging up AAA and AA paper in recent years, precisely because it was supposed to be ultra-safe and thus, er, never lose value.
But the trend also has crucial significance for investment banks. Until quite recently, many Wall Street banks tended to value their subprime linked holdings using models, because they (and their auditors) knew it was hard to get prices for these opaque instruments through real market trades. But I am told that this autumn some banks’ auditors have started to crack down on this approach, particularly in the US, owing to the so-called “Enron factor”.
More specifically, the experience of living through the Enron scandals earlier this decade means that the audit industry is now terrified that it could face lawsuits if it is perceived to be too lax towards its clients. So some now appear to be demanding that their banking clients reprice their mortgage assets according to the only visible market tool – namely the ABX. It is thus little wonder that some banks have suddenly been forced to increase their writedowns in recent weeks. Indeed, I would wager that the pernicious combination of ABX and the “Enron factor” is a key reason for the recent shocks emanating from Merrill Lynch.
However, the rub is that while auditors at some Wall Street banks are becoming quasi-evangelical about the need to reprice subprime assets, there are still other, vast swathes of the financial system which have not been touched by the full blast of transparency yet. Moreover, many financiers outside the world of Wall Street banks remain very wary of rewriting their mortgage assets to current ABX price levels, due to a lingering hope that the recent ABX slump will remain temporary.
No wonder that my banking friend is now furtively resorting to barter, to unwind his clients’ investment portfolio. And no wonder that investors are currently so suspicious about the health of financial entities – and so nervous about the potential for secondary shocks. This new wave of fear is unlikely to vanish quickly. Call it, if you like, The 2007 Credit Crunch Story, Part II.
it is only too bad that the regulatory framework that was supposed to prevent these problems in the aftermath of enron didn't; but at least it is forcing the bubble in investment banking shamelessness to pop before it gets any larger and more fraudulent. pressure is building beneath the balance sheets of many major wall street banks, as well as european banks and smaller regional american lenders. it's also tearing apart the monolines, insurance underwriters for all manner of debentures, including mortgage backed securities.
The biggest single reason for the decline in equities was the revival of worries that big banks in the US and Europe would unveil further credit write-offs. Another focus of concern involved a less well-known pillar of the global financial system – smaller specialist insurers that provide credit guarantees to lenders and investors.
Shares in Radian, a private mortgage insurer, fell 19 per cent, after its first quarterly loss, due to mortgage-related problems. MBIA and Ambac, the two biggest bond insurers in the US, have also experienced dramatic declines, amid fears they, too, could be nursing unseen subprime-linked problems.
MBIA and Ambac – often called “monoline” insurers – say that they are well positioned and that their exposure to subprime assets is very small. But analysts fear that a worsening of the crisis could result in their losing their top-notch credit rating.
That, in turn, could trigger a “domino effect” that would cut the value of the bonds they have insured. The companies insure both complex securities backed by mortgages and less risky municipal bonds.
These concerns triggered a sharp rise in the cost of insuring monoline debt against default. The broader cost of buying protection against default of a basket of European and US bonds also reached the highest level in several weeks.
shares in the monolines fell 30-40% this week.