When names like Goldman Sachs, BNP Paribas and UBS Warburg start reporting major losses in hedge funds invested in mortgage-backed securities, and the central banks of every major industrialized country begin to intervene in the credit markets, it's increasingly evident that a financial emergency may be starting to unfold across the world.
Day by day, the situation grows insensibly worse. Follow me below the fold for more exploration on this topic which touches all of our lives.
Meanwhile, reported everywhere else except in the US, China makes threatening noises about dumping dollars on the market.
The American stock exchanges continue to shed value as further detonations in the credit markets haunt Wall Street investors. Last week, I diaried on the topic of the deteriorating California real estate market and particularly the fact that credit problems are spreading beyond the subprime loan market into much more dangerous areas of the financial markets.
More bodies littering the landscape, starting in Houston:
HOUSTON (AP) - Aegis Mortgage Corp., which last week stopped making new loans and laid off a substantial portion of its staff, has filed for Chapter 11 bankruptcy protection.
The company, whose owners include private-equity firm Cerberus Capital Management, made the filing Monday in Delaware. It said the action was necessary 'to address financial challenges resulting from the recent extraordinary decline in conditions in the secondary mortgage market and national real estate market.'
...
In court papers, Aegis -- at one time one of the top 30 largest U.S. home lenders -- said its estimated number of creditors is between 1,000 and 5,000. It also estimates both its assets and liabilities at more than $100 million.
This is a relatively small entity but by no means alone.
Santa Fe, New Mexico:
NEW YORK/BANGALORE (Reuters) - Thornburg Mortgage Inc. (TMA.N: Quote, Profile, Research) said on Tuesday it does not plan to file for Chapter 11 bankruptcy protection, even after liquidity problems caused the mortgage lender to delay its dividend and sparked a 47 percent plunge in its share price.
Chief Operating Officer Larry Goldstone told CNBC television that the real estate investment trust has "no intention" of seeking protection from creditors, and that "finding liquidity in the marketplace does exist for us."
He also called Thornburg "clearly a going concern."
Earlier Tuesday, Thornburg said it will pay its quarterly dividend of 68 cents per share on September 17 rather than on August 15. It cited "significant disruptions" in the mortgage market and a "sudden and unprecedented decline" in prices for its securities.
Thornburg also said its book value per share had fallen to $14.28 as of August 13 from $19.38 as of June 30, with most of the decline in the last week.
It said it was exploring strategies to improve shareholder value, including "the opportunistic sale of our mortgage assets."
Um, good luck there, buddy.
Germany:
The biggest international victim to date is a mid-sized German bank called IKB Deutsche Industriebank that its peers, including a government-owned bank, stepped in to rescue earlier this month, taking over $11 billion of credit lines and putting up a $4.7 billion funding package. IKB had been an aggressive player in the CDO market, through two off-balance sheet firms that it used to pump up its commission income and advisory fees. In the end, its exposure to dodgy securities through these two firms far exceeded the bank's liquidity and equity capital.
Hmm. Shades of Enron. "Off-balance sheet entities." Looks like someone's going to jail. This German bank was forming companies to buy assets from itself and then pay itself higher commissions and fees, effectively committing securities fraud. Anyone care to guess whether they're the one bad apple in the barrel?
France:
PARIS (Reuters) -- France's biggest listed bank, BNP Paribas, froze €1.6 billion ($2.2 billion) worth of funds Thursday, citing the U.S. subprime mortgage sector woes that have rattled financial markets worldwide.
The frozen funds amount to less than 0.5 percent of funds under management for the eurozone's second biggest bank by value, but later in the day a separate European fund valued at €750 million was frozen too, and a Dutch bank pulled its planned new listing after suffering subprime losses.
BNP Paribas said it was barring investors from redeeming cash from the funds.
"The complete evaporation of liquidity in certain market segments of the U.S. securitization market has made it impossible to value certain assets fairly, regardless of their quality or credit rating," it said in a statement.
"... BNP Paribas Investment Partners has decided to temporarily suspend the calculation of the net asset value as well as subscriptions/redemptions, in strict compliance with regulations, for these funds," it added.
This latest subprime fallout came as Germany's Bundesbank held a meeting of those involved in the rescue of Europe's highest profile subprime victim yet, lender IKB and as the European Central Bank said it stood ready to act if needed to ensure smooth functioning of markets.
BNP Paribas said the three funds had declined rapidly in size in the past few weeks to €1.593 billion ($2.19 billion) Aug. 7, down from €2.075 billion July 27. The bank has €326 billion of assets under management.
Australia:
The warning from Rams, the first Australian home-loan company to say profit may be hurt by the deepening crisis in credit markets, follows bankruptcy filings in the U.S. by American Home Mortgage Investment Corp. and New Century Financial Corp.
The company's shares fell 34 cents to A$1.41 in Sydney. The stock has slumped 43 percent since it was sold to the public at A$2.50 and began trading on July 27....
Rams, which has 80 branches in New South Wales, Victoria, Queensland and Western Australia states, said it had no investments in U.S. subprime loans, the source of the spreading turmoil in credit markets. All the company's loans have 100 percent mortgage insurance, it said.
Looking carefully at the situation, it's pretty clear that a liquidity crisis is not yet occurring. Instead, it's the fear of a liquidity crisis that is pummeling stocks and the financial markets - at least at present.
I'm frankly hoping that such a situation doesn't come to pass. However, I'm deeply concerned. The mortgage-backed securities market became the equivalent of heroin to the banking sector across the world. Because rating agencies like Moody's publish their credit rating criteria, it's been all too easy for purveyors of questionable credit instruments to achieve "AA" and "AAA" credit-worthiness ratings when in actuality the assets backing these securities were entirely fragile, their value based on a real estate market that had to continue to rise in order to protect the value of the credit investment.
We all know what eventually happens when everybody assumes such a rosy scenario. Just as a small example, the management of Enron based their Ponzi-scheme business model on the assumption of a continuously rising stock price, and tailored their financial reporting to match that aim (while suborning their outside accounting firm to conspire in falsifying financial results).
These fake-investment-quality securities must be reformed or abolished. At the very least, the rating agencies should be told in no uncertain terms that investment-grade rating criteria should be closely held. The Chinese wall between rating agencies and securities firms should be rebuilt.
The numbers we're talking about seem huge. Goldman pumping $3 billion to bail out a hedge fund. BNP Paribas shutting down three large hedge funds. However, the size of the overall market dwarfs any current agglomeration of bankruptcies and fund disruptions. So far.
The European Central Bank injected over 100 billion Euros into the Euro Zone banking system. According to the New York Times, that action has largely calmed down the European financial trading system, which had frozen owing to European banks completely stopping making loans to one another.
It may be a different story in the United States, where the subprime mortgage market and its associated securities investments continue to reveal unpleasant surprises. As I diaried, the credit spread is increasing between Treasury bonds and the rates people will be expected to pay for access to credit. The problem is hitting hardest the once-hot REIT (real-estate investment trusts) sector, in which major firms are blowing up across the landscape. For example, going back a ways, New Century Financial blew up in March, on the hook for over 8 billion in losses. It wasn't enough to stop the Dow from hitting 14,000, but it was a harbinger of worse things to come.
Overall, lenders in the so-called subprime sector made $640 billion in mortgage loans last year, about a fifth of the total mortgage market and nearly double the amount from 2003.
New Century Financial detailed a new series of financial problems in a filing with the Securities and Exchange Commission early Monday.
Irvine, Calif.-based New Century said that all of its own lenders are cutting off financing, that it has been found in default of many of its financial agreements, and that it does not have the funds necessary to meet its obligations, which could reach $8.4 billion. The company's market value has shriveled to only $178 million.
Unfortunately, most subprime mortgage loans made within the last few years have yet to reset. Now that the risk premium is skyrocketing (represented by the credit spread), I can't see any way in which the 600 billion-plus subprime mortgage market can withstand the worsening situation. (This is 20% of the overall mortgage market in 2006.) Few people involved in these loans are going to find it easy to refinance, particularly if they need a jumbo loan. Some people in the business think that things will settle down within the next couple of months.
So far, the international effects seem to have been contained. But my guess is that this situation will take much longer to play out. The heaviest bloodshed is likely to occur in the States, where innovative, unregulated home financing and falsely-rated asset-based securities will combine to litter the landscape with the bodies of dead loan companies, REITs and even banks.
And the hedge fund sector will never be quite the same. This is the first time that this refuge of the wealthiest investors has suffered significant losses since their invention. Things could get worse before they get better here, and a renewed attack on them is imminent.
As a final note, a very useful Mortgage Lending Blog page acts as a clearinghouse for a broad spectrum of news on the onrushing mortgage lending/credit market meltdown. This is a good place to go for the body count.
***UPDATE*** Thnk the Fed has enough flexibility? The Chinese hold almost a trillion dollars in American securities. If a big emergency happens, will the Fed be able to intervene? I'm starting to doubt it.