Wednesday, November 7, 2007

A View Of the US Economy From England - The Consequence of Mortgaging a Nation

My favorite author, Ambrose Evans-Pritchard, is back with another point of view from England about the US Economy. His points are clearly European and as a result give a different perspective on the US then what we normally receive here. Text in bold is my emphasis. From the UK Telegraph:

The peak pain for America's sub-prime debtors will hit next spring as interest rates jerk upwards with venomous effect on all those "teaser" loans taken out at the height of the property bubble in 2005 and 2006.

A cascade of defaults will inevitably follow through next summer and beyond, hobbling any recovery in the global credit markets for months to come.

The losses are already bad enough. A study by Barclays Capital found that 16pc of sub-prime mortgages taken out in January 2006 are in default, and 28pc are in arrears beyond 30 days. Struggling to catch up, the rating agencies downgraded a further $100bn of mortgage debt in October alone.

This mortgage debt – mostly packaged into collateralised debt obligations (CDOs) and sold to banks, hedge funds, insurers, and pension funds across the world – is tracked by the ABX index. This shows that some of the AA tranches have lost 20pc of their value, while the "toxic" BBB tranches have lost almost four fifths.

While it is hard to calculate the damage, it is clear that roughly $2,000bn (£1,000bn) of sub-prime debt and related 'Alt-A' debt is worth far less than book value.

Some can disguise these paper losses. Others are not so lucky. Those that rely on short-term funding in the US commercial paper market can no longer roll over loans, forcing them to sell assets into a sliding market. The asset-backed commercial paper market has contracted for 12 weeks in a row, cutting off $300bn in funding.

Deutsche Bank chairman Josef Ackermann warns that total sub-prime losses are likely to be $150bn to $250bn, triple the bank's estimate in July.

While Citigroup has come clean with write-down of up to $11bn in mortgage loans, few lenders have stepped forward to take their punishment.

The suspicion is that banks in Germany, Spain, and Britain are still trying to muddle through in the hope that the market for CDOs will recover enough to bail them out.

Suki Mann, a strategist at Société Générale, said the credit markets feared an "Armageddon scenario" once again. "We're back to pre-September risk-aversion mode," he said.

Hans-Redeker, currency chief at BNP Paribas, said the banks could not easily reveal their true losses. "Our view is that these losses are so substantial that it puts current business models at risk," he said.

The Federal Reserve has slashed interest rates from 5.25pc to 4.5pc since September but this comes too late to head off what is now the worst property crash since the Great Depression.

The Case-Shiller index of house prices in the 10 biggest US cities fell 5pc in August from a year earlier, and the downturn has since accelerated. Sales have collapsed to the lowest levels since modern records began, while the glut of unsold homes has reached a record 10.5 months supply.

"The data has been much worse than people realized," said Huw van Steenis, chief bank analyst at Morgan Stanley.

"There will be further write-downs. The liquidity problem of a few months ago has now changed into a capital problem, which is more difficult to solve. Banks have chewed through their capital ratios and this is going to put a brake on lending." he said.

Until now, the US economy has held up remarkably well. The US October employment report showed a gain of 166,000 jobs, but this tends to be a lagging indicator. A clutch of consumer surveys now point to a sharp fall in confidence.

It is far from clear that Europe and Asia shake off a cold as America sneezes. Japan – still the world's number two economy – has tipped abruptly into recession. Housing starts fell 43pc in August and 44pc in September, touching a four-decade low. Japanese wages have dropped in nine of the last 10 months, and unemployment has jumped to 4pc, from 3.6pc in July.

Eric Chaney, Morgan Stanley's euro-zone economist, said there was now a risk of a manufacturing recession in Europe. "Production has fallen off a cliff in Germany and has slowed in The Netherlands, France, and Belgium. Something has happened. We take the warning seriously," he said.

Ultimately, the US Federal Reserve can slash rates back to 1pc again – or even to Japanese-style zero rates – if need be. But it cannot re-open the floodgates of liquidity at a time when oil has reached $94 a barrel.

Nor can it easily act alone while the dollar is sliding to all-time lows, and risks a rout.
The Fed is hemmed in. This is the price America must now pay for mortgaging the nation.

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