Interest Rate Roundup

Thursday, August 09, 2007

French bank gets fried by mortgage meltdown

More evidence the mortgage meltdown is anything but contained is coming from overseas this morning. BNP Paribas, the largest bank in France, has frozen three funds that invest in asset-backed securities, or ABS. BNP will not allow investors to pull money out. It will not allow investors to put new money in. In fact, it won't even provide a value for the funds -- Parvest Dynamic ABS, BNP Paribas ABS Euribor and BNP Paribas ABS Eonia. These aren't tiny funds. They're funds with $2.76 billion in assets.

BNP's reason for the freeze: "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." In other words, the subprime mortgage meltdown is causing pricing for all kinds of structured bonds to go haywire.

Here's the big-picture problem: We've been led to believe that the explosion of investment in all these newfangled investments (CDOs, CDO squared, CLOs) ... that the explosion in the securitization of every type of loan under the sun ... that the ballooning exposure to complex, hard-to-value, over-the-counter derivatives ($415 trillion in notional value outstanding as of Dec. 31 2006, more than quadruple the level of six years ago, according to the Bank for International Settlements) ... and that the origination of all kinds of new "creative financing" mortgages in the home loan industry ... was a good thing.

But now the rubber is meeting the road. It turns out that all these stupid mortgages are blowing up in borrowers' and lenders' faces. It turns out that these complex instruments just can't be valued accurately, if at all. It turns out that Wall Street just got too "smart" for its own good. Now, we're trying to sort the mess all out. And unfortunately, the risk of a 1998-style meltdown is very real as a result.

Heck, look at what's going on in the European money market this morning -- the overnight London Interbank Offered Rate, or LIBOR, is surging. It just soared to 5.86% from 5.35, according to the British Bankers Association, putting it at the highest level since the start of 2001. 3-month LIBOR rose to 5.5% from 5.38%. 6-month LIBOR climbed to 5.39% from 5.34%. The European Central Bank has responded by lending the market the euro equivalent of $130 billion.

This is serious stuff. It's a sign that liquidity is seizing up amid fears of subprime mortgage contagion. LIBOR hardly ever moves on credit concerns, only in response to increases in the federal funds rate. And guess what's tied to LIBOR? All kinds of short-term loans, including some Adjustable Rate Mortgages.

Bottom line: Fasten your seat belts.


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