IMF Warns Subprime Crisis Losses 'May Be Higher'

Source : The Straits Times, Jan 17, 2008

WASHINGTON - THE United States subprime mortgage crisis will likely produce deeper problems than expected because not all market players have 'come out clean' about their losses, the International Monetary Fund said.

'Some analytical work modelled on conservative assumptions suggests that potential losses may be higher and further capital injections are likely,' Mr Manmohan Singh and Mr Mustafa Saiyid wrote in an IMF report.

'Most banks in the United States have not yet marked their assets to genuine transaction prices,' the report said on Wednesday.

Some market participants 'have come out clean such as a few US hedge funds that have written off the value of all junior notes issued by its structured vehicles,' the report said.

The global markets turmoil that erupted last year amid rising defaults on US subprime mortgages was in part due to a lack of appropriate measures to evaluate the risk of new financial products.

Subprime mortgages - home loans given to people with poor credit histories - were packaged into structured securities such as collateralised debt obligations, of CDOs.

Following the collapse of the US subprime market in mid-2007, market worries about the exposure of the structured securities to the subprime crisis caused a credit freeze that made many market players use valuation models that no longer worked in the meltdown, the report said.

Recent moves by financial institutions to bring off-balance-sheet structures like CDOs on the balance sheet are not at explicit 'transfer prices' and thus 'may not be a full reflection of potential losses'.

The IMF report suggested that market participants seek to regularly put a portion of their complex structured securities on the market to obtain a valid valuation.

Some market players 'increasingly relied on ratings as a measure of default risk and inappropriately compared them to those on plain vanilla corporate debt, which has different sensitivities to market conditions'. -- AFP

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US banks seeing higher delinquencies on more than just mortgage payments

NEW YORK - THE bill for America's excessive borrowing during the housing boom has arrived, and more people are having trouble paying it.

JPMorgan Chase and Wells Fargo, two of the biggest United States banks, on Wednesday joined a growing chorus warning that the subprime mortgage mess is just the start of a sweeping lending crisis. And some fear that consumers falling behind on all kinds of loan payments could tip the economy's scale toward recession.

Strapped consumers are having a tough time making payments on credit cards, home-equity loans, and even for their cars. This has caused three of the top five US commercial banks that have already reported damaging fourth-quarter results to set aside some US$12.5 billion (S$17.9 billion) to cover future loan losses - and that number will likely grow as the year wears on.

Problems in the subprime mortgage market are rapidly spilling over into other areas of the economy. No matter what the experts call it - a recession, slowdown or even the makings of a depression - it's clear banks are under mounting pressure to be more cautious about lending.

'If consumption growth stagnates, the odds of a recession are incredibly high,' said Mr Andrew Bernard, director of the Center for International Business at the Tuck School of Business at Dartmouth.

'All the pieces of household financial health are starting to be shakier, especially at the low end.'

He and others are paying close attention to what top US banks say about their customers' payment habits. Many view this as an early indicator about where the overall economy is headed, but there are other signs that are troublesome.

The stock market has had its worst start to the year in three decades, with investors rattled by signs from the Labor Department that unemployment is on the rise and retail sales are on the decline.

Further, the Commerce Department reported on Wednesday that higher costs for energy and food in 2007 pushed inflation for the year up by the largest amount in 17 years.

There was no sign of a turnaround in the last few months of the year. The Federal Reserve reported that the economy grew at a slower pace in late November and December as credit problems intensified and consumers tightened their spending.

To some, it appears that the Fed came to its rate-cutting decision in August a bit too late. Others point to the falling dollar and surging oil prices, factors that usually prevent the central bank from easing its monetary policy.

While debate persists about the Fed's timing and the extent of the slowdown, bank executives - who have scrambled to prepare for another tumble in home prices and higher unemployment in 2008, feel academic definitions are beside the point.

'We're not predicting a recession - it's not our job - but we're prepared,' JPMorgan Chase CEO Jamie Dimon told analysts after the nation's third-largest bank wrote down US$1.3 billion and said profit dropped 34 per cent.

His financial institution did not do all that bad. Rival Citigroup fared the worst during the fourth quarter, losing US$9.83 billion after writing down the value of its portfolio of mortgage and mortgage-backed products by US$18.1 billion.

Wells Fargo, a more traditional bank that avoided last year's trading woes, saw its profit fall 38 per cent due to troubles with home equity loan and mortgage defaults.

JPMorgan is girding for home prices to decline further in 2008 by 5 per cent to 10 per cent; Citigroup's estimate of 7 per cent falls within that range, too.

'The banks are the infrastructure for everything, the heartbeat of the market,' said Mr Chris Johnson, president of Johnson Research Group. 'They need to be fixed before the market, and economy, can move forward with confidence. They need to get all their dirty laundry out there.'

Banks and card companies like American Express - which warned last week that it would add US$440 million to loan loss provisions - said in the regions where home prices are declining, card default rates are rising faster. The same goes for auto loans, subprime mortgages and home equity loans in these areas, which include Florida, Michigan and California.

A big reason for the rise in credit card default rates is that they are returning to more usual levels following a change in bankruptcy law that sent rates lower for a time. But the fact that more losses are being seen in the weaker parts of the country shows the increase is economically driven as well.

Analysts believe this means one thing: Consumers will be the ones paying for years of lax lending standards by US financial institutions. Many will become more restrictive about who gets credit in a bid to stem future losses - and that could curb consumer spending, which accounts for more than two-thirds of the economy.

'We've pushed the envelope,' Mr Johnson said. 'Along with the joy of a market that goes as high as ours is the agony of when it starts to correct itself.' -- AP