Tuesday, June 26, 2007

Trouble On The Horizon?

The Fed has been saying for some time that the problems with subprime mortgages and the housing market are "contained" and should have little to no long-term impact on the American economy. So what do you make about this story in the Financial Times this morning?

Shares in Bear Stearns dropped another 3.2 per cent on Monday as the Securities and Exchange Commission sought information from the bank about its two troubled hedge funds and a drop in US home sales sparked more fear about the state of the mortgage market.

Bear shares are now down about 19 per cent since January on fears that turmoil in the subprime and wider mortgage market could take a heavy toll on the bank’s earnings. Goldman Sachs and Lehman Brothers shares each dropped about 2 per cent on mortgage concerns.

The drops came as new data showed sales of existing homes fell slightly last month to a four-year low as the backlog of unsold homes rose, dampening hopes of a recovery in the sector.

Bond yields remained lower as investors worried that financial institutions could face further losses in the mortgage market. The 10-year bond yield fell to 5.08 per cent on Monday, against 5.13 per cent late on Friday.

In a third consecutive monthly decline, 5.99m homes changed hands in May, against the 5.97m economists had expected, and 0.3 per cent fewer than in April, according to the National Association of Realtors. It was the lowest rate of sales since June 2003.

The number of homes for sale rose to a 15-year high of 4.43m, or 8.9 months supply, almost double the supply from two years ago.

“The current level [of inventory] is approximately a million units above normal, a figure that glaringly illustrates the housing market’s biggest problem,” said Tony Crescenzi, bond strategist at Miller Tabak & Co.

Sales of existing homes make up about 85 percent of the housing market.

Mr Konstam said Moody’s estimated that sales of complex financial instruments, known as Collateralised Debt Obligations reached $506bn in 2006, of which more than half contained subprime exposure. “If there is contagion, the problem certainly has sufficient scale to become a financial event,” said Mr Konstam.

The value of such instruments is derived from conditions in the housing market.

Michelle Meyer of Lehman Brothers said large and rising inventories could lead to higher foreclosure rates for borrowers struggling to pay off mortgages, as high levels of supply make it more difficult to sell homes quickly.

notes that a second fund has now reported trouble because of its subprime loan exposure:

And, Queen's Walk Investment Ltd., a United Kingdom-based publicly traded closed-end fund managed by Cheyne Capital Management (U.K.) LLP, said it had a net loss of €67.7 million ($91.2 million) in the first quarter and a loss of €98.8 million in the fourth quarter, due to losses in the mortgage-backed bond market. The net asset value of the securities in the fund fell 26.8%. More broadly, bond markets show signs of trouble digesting recent issues of corporate debt.

More trouble to follow? And if so, a major financial event to follow that? Or are troubles with subprime loans, mortgages, and the housing industry contained and no problem as the fed says?

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