$1 Trillion In Toxic Debt?

Markets Fear Banks Have $1 Trillion In Toxic Debt

By Sean O’Grady, Economics Editor | 8 November 2007

A new phase in the credit crunch, one of “$1 trillion losses” seems to be dawning. The crisis at Citigroup and renewed doubts about some of the world’s leading banks disquieted stock markets on both sides of the Atlantic yesterday, with the fractious mood set to continue.

The FTSE 100 fell severely, with Alliance & Leicester and Barclays (at a two-year low) singled out for punishment. In New York, Citigroup, down to multi-year lows, weighed on the Dow Jones index, which also fell severely. Merrill Lynch, Goldman Sachs and Lehman Brothers also dropped on speculation they face more writedowns on top of the $40bn (£19bn) announced in the past four months.

Bill Gross, the chief investment officer of Pacific Investment Management, said US mortgage delinquencies and defaults would rise in 2008.

“There are $1 trillion worth of sub-primes, Alt-As [self-certified] and basically garbage loans,” he said, adding that he expects some $250bn in defaults. “We’ve only begun to see the pain from rising mortgage payments.” Brian Gendreau, an investment strategist at ING, commented: “Financials are 20 per cent of the S&P 500 and if that sector doesn’t do well, all bets are off. People just don’t know what’s on the balance sheets.”

The banks remain unwilling to lend to each other, preferring to rebuild their balance sheets and “hoard liquidity” to buttress themselves against any shocks from repatriating off-balance-sheet losses from their special investment vehicles (SIVs). However, this tightening up has led to a vicious circle. Making credit tougher has exacerbated the problems of struggling mortgage holders in America; default rates then rise and make the banks even more exposed to losses as credit agencies downgrade their assets. This seems to be what happened at Citigroup. The admission that it was unable to assure investors that a potential $11bn write-down for sub-prime mortgages would not grow has led to this fresh fit of extreme nervousness. Huge write-downs by Merrill Lynch ($7.9bn) and UBS ($3.4bn) have not helped.

Samir Shah at Landsbanki Securities said:

“People thought most of the bad news had been priced in. It seems we’re entering a second phase of the credit squeeze. We’re going back to a place where liquidity is drying up and volatility is increasing.”

Barclays has seen its shares savaged.

“There is a concern about the extent of the debts among the banks generally and who will be left holding the debt,” Richard Hunter, of Hargreaves Lansdown, said. “There’s a read-across to Barclays Capital. People are concerned about the exposure it has.” Profit growth at its subsidiary was “strong”, the bank declared last month, though it offered no comment yesterday.

Alliance & Leicester also suffered from vague rumours that it had turned to the Bank of England for emergency funding. An A&L spokesman offered this reassurance:

“Each week in recent months, including last week, Alliance & Leicester has successfully raised the funds it requires. We have also continued our share buy-back programme.”

The Chancellor, Alistair Darling, also pleaded for calm.

“We are experiencing an unparalleled period of financial uncertainty caused by the problems in the US housing market,” he said. “I believe that we can get through that. Many banks in this country have very strong balance sheets after years of making very good profits.”

Meanwhile, on the continent, newspaper reports named two German banks— WestLB and a small specialised bank for professional people— as possible next victims of the crisis.



Banks Are Braced For Months Of Pressure

By FT Reporters | 5 November 2007

Fears are growing that the turbulence in the financial sector will be more protracted than expected as big US and European banks come under intensifying pressure due to losses on US subprime mortgage securities. Shares in banks and insurers continued to tumble on Monday as analysts warned that losses from mortgage securities could leave some institutions short of capital. The turmoil has already cost chief executives their jobs at Citigroup, Merrill Lynch and UBS, and prices in the money markets on Monday suggested traders expected the credit problems to last at least into next year.

Federal Reserve governor Randall Kroszner said "conditions for subprime borrowers have the potential to get worse before they get better". He called on mortgage investors and servicers to consider modifying subprime loans en masse rather than on a case by case basis "to help large groups of borrowers".

Meanwhile, bankers cast doubt on the plan, backed by the US Treasury, to launch a "superfund" to purchase distressed assets from troubled investment vehicles.

They said that the management upheaval at Citi, which lost its chief executive, Chuck Prince, on Sunday and the growing strain on its balance sheet were likely to slow down efforts to get the fund off the ground. In addition, some of the senior executives heading the project at Bank of America, one of the three key banks involved, were recently sacked in the shake-up of its investment bank.

Citi shares were off nearly 5 per cent after dropping 11 per cent last week, while the cost of insuring its bonds against default rose to record levels. Fitch, the credit rating agency, downgraded Citi's debt one notch.

"Investors now believe the credit squeeze will last a lot longer [than before]," said Gerald Lucas, senior investment adviser at Deutsche Bank, who pointed out that the future cost of raising dollars in the interbank market— through a forward contract— rose sharply in New York.

Huw van Steenis, an analyst at Morgan Stanley, added: "The bear market for banks is unlikely to end until we get some clarity on the extent of the losses."

Investors pushed down shares for other banks amid fears of future writeoffs. Specialist insurers that provide credit to lenders and investors remained a concern for investors. MBIA shares were off more than 6 per cent.

Frederic Mishkin, a US Federal Reserve governor, tried to reassure investors by stressing that the US economy appeared well placed to absorb the subprime problems.

Normxxx    
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