“The credit squeeze is turning from a firm embrace into an uncomfortable bear hug,” as the FT put it.
The sterling three-month interbank lending rate has hit a two-month high and the dollar rate has also jumped amid renewed jitters over financial institutions’ exposure to the crumbling US mortgage market following news of banks’ rapidly increasing writedowns of subprime mortgage-related assets.
The price of insuring corporate bonds is approaching levels last seen at the height of the summer crisis. UK mortgage group Paragon (PAG) has been hit by the squeeze, while the woes of US mortgage giant Freddie Mac (FRE) are also causing concern.
What happened to Freddie Mac?
America’s second-biggest provider of mortgage financing has announced a $2bn third-quarter loss – only eleven days after Fannie Mae (FNM), its larger counterpart, reported a $1.39bn shortfall.
The two firms buy home loans from mortgage lenders, thus providing the latter with cash to write more mortgages; they own or guarantee around 40% of America’s mortgages.
They make money by packaging the mortgages they buy into bonds and guaranteeing them, but when defaults rise, the fees they receive for this tumble, as they have to carry the can.
Thanks to the deteriorating housing market, Freddie was forced to set aside money for bad loans as well as write down the value of other mortgage-related assets it holds; in recent years it has scooped up subprime-backed securities.
What next?
The upshot is that its capital base is now only just above the regulatory minimum, so there’s no room on its balance sheet “for it to even attempt to shore up US housing by buying more loans”, said Antony Currie on Breakingviews.
This suggests the housing malaise will spread further into prime territory; fewer available loans implies “a further exacerbation of the housing downturn”, said Howard Shapiro of Fox-Pitt Kelton: “even less credit available” and steeper price falls.
That in turn portends a fresh round of losses on mortgage-backed securities as defaults keep climbing, as Tom Bawden pointed out in The Times, which will hamper financial institutions’ ability to lend and thus fuel the broader credit crunch.
This already looks bad enough: according to Goldman Sachs, the spiralling losses from subprime mortgages may force the US banking system to cut lending by up to $4trn, which would herald a “substantial recession”.
Recent data has hardly been encouraging anyway, with demand for housing construction permits sliding to a 14-year low, job growth slowing and retail sales, excluding cars and petrol, running at an annual rate of -1% over the past three months. “A nightmare on Main Street,” as Currie put it, is looming.