The Subprime Mortgage Meltdown Goes Global
The Subprime Mortgage Meltdown
The global credit market crisis — caused by the US subprime mortgage mess — involving housing finance loans to borrowers with poor credit ratings who have low or unreliable incomes, is worsening instead of getting better. US house prices are falling and mortgage delinquencies are rising at an alarming rate. The financial institutions involved in the packaging and insurance of and investment in subprime mortgage-based securities are getting whipsawed as more information comes out about their ballooning losses. This relentless crisis could push the US, if not the global economy, into a recession next year. And, the impact of the crisis has impacted the prime bonds and commercial debt obligations.
Despite the Fed’s repeated interest rate cutting, the crisis is turning into a financial meltdown for major banks as well as other financial institutions, such as insurers and hedge funds. Merrill Lynch and CitiBank have been forced to terminate their respective CEO’s as a result of their losses in these investments.
Stan O’Neal of Merrill Lynch resigned last week, saving the Board from having to fire him. Charles Prince, the heir apparent to Sandy Weill, was replaced today by Robert Rubin. And, Rubin takes over a Bank that many knowledgeable sources are predicting will be forced to recognize billions of dollars in additional losses before the end of the calendar year. To make matters worse for these two financial giants, whose share prices have been pummeled recently, the US Securities and Exchange Commission (SEC) is probing their valuation of mortgage securities and disclosures to investors for possible violations.
The Fed, evidently more concerned about a possible complete breakdown of the financial system than another bout of virulent inflation reminiscent of that in the late 1970s, resumed its looser monetary policy last week, which it had started in September. It cut both the target federal funds rate and the discount rate 25 basis points to 4.5 percent and 5.0 percent, respectively. It justified its second round of rate cuts by pointing to the slowdown in the real economy and the continued turbulence in the financial sector.
Although it discouraged expectations of further cuts, citing its concern about higher inflation, it appears now that the Fed readily obliges the repeated clamors of the financial markets for cheaper money. As the US dollar continues to depreciate, partly due to lower short-term interest rates, it is referred to derisively as “The Bernanke” after Fed chairman Ben Bernanke. As The Economist writes, “the Greenspan put has in effect been replaced by the Bernanke pushover.”
Credit rating agencies such as Moody’s, which had earlier failed to properly evaluate the risk of the mortgage-backed bonds and their derivative CDOs, are now rushing to mark them down. The best quality AAA-rated ones are valued at below 80 cents on the dollar and the worst quality ones below 20 cents on the dollar. This markdown is beginning to hard hit the insurers, called monolines, such as MBIA and Ambac, which had insured these securities. If the credit rating of the monolines themselves were to be downgraded below AAA, then the crisis would worsen further, as the ratings of securities insured by the monolines drop automatically. The monolines, because of their insurance losses and below-AAA rating, would have to raise more capital in a market where credit is getting very scarce and expensive.
If this financial crisis was a 9 inning baseball game, then we would just be finishing the first inning. And, the two starters for both of the teams have already been knocked out of the box!
