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04 March 2024

Connecting credit dots prolongs crisis

By Agencies


The global credit downturn is unlikely to end any time soon given how slowly Wall Street banks have moved to connect the dots between themselves, bond insurers, credit indexes and other pieces of the credit puzzle.

Banks, including Citigroup and UBS, have already absorbed about $150 billion of mortgage and corporate loan-related losses, but that may jump by almost 50 per cent, according to brokerage Oppenheimer & Co. in New York. That is because the tottering bond insurance companies some banks used to guarantee their mortgage bets are facing their own troubles and may not deliver on policy claims.

If Wall Street banks suffer another wave of write-downs on assets like commercial property loans or repackaged subprime mortgages that were insured, they're likely to pull back even further on extending credit to companies and consumers, helping push the US economy into a recession.

Consider banks' failed subprime mortgage investments. Apparently the banks did not realise that their insurers, which guarantee payments on almost $1 trillion of structured finance bonds, made the same mistake they did: Trusting the rose-tinted views of model-driven experts on repackaged mortgage securities called collateralised debt obligations, or CDOs.

"The CDO folks, who were cut from the same cloth as CDO professionals all around the Street, who didn't treat bonds as real things but treated them as mathematical abstractions, blew up the bond insurers the same way that the same kinds of guys at Merrill (Lynch) and Citi caused major explosions in their firms," said Mark Adelson, a consultant at Adelson & Jacob Consulting in New York.

Bruce Dobish, a buyer of distressed real estate and former staffer at now-wobbling bond insurer FGIC, cast the net wider to include credit-rating services.

"These (banks) and the ratings agencies and the monolines (bond insurers) tend to be comprised of a lot of youthful, bright individuals who lack real-world experience," Dobish said. "They're not going to remember back 20 years ago."

Rob Haines, senior insurance analyst at CreditSights in New York, said: "They all got it wrong."


The fragility of US bond insurers is not Wall Street's only oversight.

Some banks may also have to write down the value of their US commercial mortgage holdings, most likely using prices from the little-known CMBX derivatives index, which has tanked recently but was created -- ironically -- to allow players to hedge against commercial mortgage risks.

The so-called yield spread premium on the top-rated CMBX-4 index of commercial mortgage-backed securities was relatively flat on Friday at 185 basis points over interest-rate swap rates, according to a market source. That was an improvement over recent levels but still a sign of strong risk aversion.

Some analysts and investors say the index is suffering not from massive problems with commercial mortgages but because of the same factor that helped pummel its cousin, the widely watched ABX subprime mortgage index: Speculative bets by hedge funds.

With bets against subprime mortgages using derivatives so popular and therefore increasingly expensive, many hedge funds have simply moved their game to the less-known CMBX, pushing this index lower and making the US commercial mortgage market seem less resilient than it may be.

"Speculators and hedgers looked for cheaper things to short," said Derrick Wulf, portfolio manager at Dwight Asset Management in Burlington, Vermont, in a recent note.

"There may be an excess of complacency on the short side of the credit markets," he said.

Already under pressure from their accountants, banks may use CMBX prices to gauge the extent of their commercial mortgage write-downs even though the index's weakness may be exaggerated. That would hammer global markets further.

In a way, both this example and the bond insurer case suggest that the unfolding of the credit crisis is less a "contagion" spreading through markets than a gradual discovery by banks and investors that different pieces of credit markets were connected in the first place.

"People look at the whole credit crunch as a series of separate issues," said Edward Grebeck, chief executive of Tempus Advisors, a debt strategy firm in Stamford, Connecticut.

They "are finally getting around to the point that structured finance, the rating agencies and the bond insurers are all related," he said. (Reuters)