Interest Rate Roundup

Thursday, December 20, 2007

Thoughts on the latest credit market turmoil

I know I haven't posted much in the past day and a half. It's not for lack of desire -- or a lack of anything to write about! It's because I'm busy trying to wrap several things up in my "day job" before the Christmas holiday. But I'm going to take a few minutes now to touch on the biggest things going on, and try to explain what they mean for the markets. In no particular order ...

* Shares of embattled bond insurance firm MBIA are in free-fall (down another 20%+ at last count) again today. The catalyst is a new report from the insurer that it guarantees $8.1 billion of "CDO Squareds" -- or CDOs that repackage bits of other CDOs and securities. A Morgan Stanley analyst said he was "shocked management withheld this information for as long as it did," according to Bloomberg.

Standard and Poor's and Moody's have both lowered their outlook for several bond insurers, including MBIA and Ambac Financial. But so far they haven't cut their AAA ratings. The market, on the other hand, has clearly rendered its judgment about the validity of those ratings and/or the companies' earnings outlook. Credit default swaps are blowing out in the case of MBI, for instance, while the share prices of these firms have been more than cut in half in the past several months.

* Bear Stearns became the latest Wall Street firm to eat major losses due to worsening credit market conditions. The broker lost $854 million in the fourth quarter thanks in part to $1.9 billion in writedowns on mortgages.

* The asset-backed commercial paper market continues to shrink rapidly. ABCP dropped by $27.5 billion, or almost 3.5%, in the week ended December 19. That's the biggest decline in 16 weeks. More details on why this is happening and what it means can be found here.

* Shares of super-regional bank SunTrust Banks are slumping after the firm said it would buy up $1.4 billion in debt securities to prevent investors from taking losses in its STI Classic Prime Quality and STI Classic Institutional Cash Management money funds. It's going to take a pretax writedown of up to $250 million because of the purchases.

That's not all, either. In an 8-K SEC filing, SunTrust said:

"Deteriorating real estate values and the outlook for consumer credit have increased SunTrust's expectations for losses inherent in the portfolio. Provision expense recorded in the fourth quarter is currently expected to exceed net charge-offs by approximately $190 million which will increase the allowance for loan and lease losses to approximately 1.06% of total loans. Additionally, the Company expects net charge-offs in the fourth quarter of 2007 to approximate $170 million, or an annualized rate of net charge-offs to average loans of approximately 0.56%."

In other words, the hits just keep on coming. The U.S. Federal Reserve, and other global central banks, continue to bail like crazy and pump money into the system. But so far, it's an open question of whether the strategy is "working." I'm skeptical the Fed can prevent the housing market from slumping further, to say nothing of simultaneously putting out credit fires that are now burning brighter in the commercial real estate sector ... the credit card sector ... the auto loan sector ... and so on.


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