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Tuesday, April 08, 2008


the credit crisis going forward

two bits today -- first from nouriel roubini on the shape of the nascent recession. surprisingly for some who have painted roubini with too broad a brush, he forecasts an avoidance of a japanese-style malaise in favor of a shorter, sharper pattern. more opinion from calculated risk, who i think underestimates the likelihood of recessionary feedback propagating credit contraction, driving a great many businesses kept alive by easy credit in recent years to liquidation.

second -- and more interestingly -- institutional risk analytics offers this interview with jonathan rosner (via yves smith).

The IRA: So what is the Rosner view of the world? The party line in Washington and on Wall Street is that everything's fine and we'll return to normal growth in the second half of 2008.

Rosner: I see troubles radiating outward. What I mean specifically is that there is no functional change in the problems in the mortgage markets. What is really making us feel OK, at the moment, is the fact that banks are destroying shareholder capital and that they are raising new money. That's all well and good, but we still have not changed the underlying reality, namely that most of the losses taken so far are due to mark to market issues. We have not yet really seen the bulk of the underlying credit losses.

The IRA: Ditto. We have been talking about this for six months, but there seems to be a refusal on the part of many observers to accept that the losses reported to date have been primary trading book write downs vs. actual charge offs of loan losses. Citigroup (NYSE:C), for example, did just 120bp in aggregate charge offs in 2007.

Rosner: There is a lack of appreciation or maybe a lack of understanding between these two issues, mark to market losses and actual credit losses, and we need to distinguish between these two issues. I continue to believe that we are going to see further downward pressure on home prices -- regardless of what the Congress believes or intends or manipulates. Unless we actually nationalize the housing industry, there is not much we can do to avoid the downward correction in home values.


The IRA: ... But let's get back to the current mess. How do you assess the state of the real estate market and the implications of this for financials?

Rosner: We are starting to see an acceleration of the delinquencies and loss rates moving from subprime through alt-a through the prime market. GSEs like Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) are in no position frankly to do much to save themselves let along save the market. ... They are already visible in the home equity line of credit market. The HELOCs are typically committed lines and frankly people often forget that in some respects, at least in this cycle, the consumer lenders, revolving lenders, credit card lenders, are in a better place that the HELOC lenders. The revolving and credit card lenders can change your available lines overnight and change your rate terms with the same speed. The HELOC lenders cannot.

what follows is important, and puts a knife in some of the arguments surrounding walkaways.

Rosner: ... What I mean by that is that the last asset which a borrowed defaults on is the primary mortgageā€¦

The IRA: At least it used to be. The FT reported a while back that the 2006 production was the reverse, with borrowers defaulting on mortgages before credit cards or auto loans.

Rosner: No, the mortgage still is the last thing to go into default. The borrowers we've see default already are those with no other resources. Where I think we see the next leg and what I am watching carefully now is that we are seeing the drawdown of committed but undrawn lines of credit by distressed borrowers who are taking cash out of the line to pay first their primary mortgage and then revolving lines of credit. At some point we reach a terminal period where they default on their credit card and then their primary mortgage. I'm not sure it does not go in the other order, but we'll see. That is the reason, I believe, that we've seen a little bit of a slowdown, a respite from a massive spike in defaults, because the borrower who is Alt-A and prime largely, even with the decline in home values, still has access to credit. Consumers do not give up spending of their own volition. They do so only after they have exhausted all other options.

The IRA: Suggesting that we could be headed to a huge uptick in default experience in unsecured and mortgage loans in the not too distant future?

Rosner: Yes, we will see the drawdown of HELOCs until they are exhausted, resulting in an eventual upsurge in defaults on mortgage-related and revolving credit. ... I would be very wary of institutions that have HELOC exposure. For the time being, I would be less concerned with the credit card companies. And then there is the situation in commercial real estate, where the wheels are starting to shake and even fall off the wagon.

the interview covers a good deal more ground than this, but in terms of the depth and breadth of any subsequent recession this is central. it is hard to conceptualize, given the turmoil we've already seen, that banks in the main have not yet even begun to take the economic losses that are surely coming. and rosner here is only ancillarily referring to the commercial side, awareness of which is only now beginning to materialize.

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