Expected Impact Of US Sub-Prime Woes On Stock Markets Overblown

Source : The Straits Times, Aug 29, 2007

Real problem is lack of transparency by banks in dealing with the risk: UBS banker

A TOP banker with one of Europe's leading financial institutions was in Singapore this week with a message for investors still rattled over volatile markets: It's not as bad as it looks.

Zurich-based Dr Klaus Wellershoff, a member of UBS Group's managing board and global head of its wealth management research, said the fragile United States real estate market would not have the impact on global financial institutions that many are predicting.

Even if defaults on US home loans rise to US$200 billion (S$304 billion) or US$300 billion as borrowers fail to pay up, the amount would still be much smaller than the US$2.5 trillion loss in value suffered by global equities market in the past three weeks.

And this, said Dr Wellershoff, is the real problem - the lack of trust and transparency in dealing with a problem where the 'underlying risk is relatively small'.

'What is disconcerting is not the sub-prime market, where loans are made to individuals with poor credit history, but the contagion that problem has spread to other asset-backed instruments,' he said.

Repackaging the bonds does not multiply the risk, as it is like discharging a small spray of water. 'You find some contamination everywhere, but it is never going to be as big as the initial risk.'

But the fear of any form of contamination has led to an absurd situation where even triple- A-rated banks 'do not trust each other - to the extent that they wonder if the other party is more involved in the issue'.

Even though US banks have probably suffered bigger losses, European institutions have also grabbed headlines as the US sub-prime crisis unfolded.

Dr Wellershoff said: 'Europeans are too honest for this world. The two German banks that suffered losses are very minor institutions. The actual losses are not that big.'

Still, he observed that while central banks managed to stave off a global liquidity crisis by pumping billions to prop up the banking system, there is a real crisis in the US real estate market and it is far from over.

Dr Wellershoff believes the US Federal Reserve will cut interest rates to ease the pain of the country's construction sector.

'Construction activity has shrunk by one-third. It is not a slowdown in growth rate anymore and it is a crisis and so it is fair to assume that the Fed will act on it,' he said.

Cutting US interest rates will not cause the unwinding of yen carry trades where investors borrow massively in yen to buy higher-yielding assets. 'Investors who indulge in yen carry trades don't buy US government bonds. They buy something that yields higher returns...A cut in US interest rates will yield more investment opportunities,' he said.

As US interest rates fall, the returns of the equity market may improve, and this should be lucrative for carry trade investors, Dr Wellershoff added.