IMF Announces US Mortgage Crisis is a $1 trn Blunder

Rob Mackrill - Wed 09 Apr, 2008

Total losses from subprime are likely to be near $1trn says the IMF

It’s a trillion...give or take...

Goldman Sachs says so. It expects so “global credit losses” of $1.2trn. Nouriel Roubini said so some time back and notes his view has become fashionable since. “$1trn is the new size 6!” though the final tally could be higher still. And now, the International Monetary Fund says so. Losses from the US mortgage crisis may amount to the best part of a $1trn blunder ($945bn) they reported yesterday in what the FT dubbed “an Instability Report”.

This puts it ‘at least on a similar order of magnitude in dollar terms’ with the 1990s Japan crisis, though there are differences say the IMF.

This time it’s not just the banks of a single country that are left holding the bag, as happened with the Japanese banks in the 1990s. The age of the internet and globalisation has increased the reach of the financial muck spreader to cast its manure around the planet to such an extent that most subprime losses have landed on non-US plates. European bank subprime losses expected to total $120bn, will be only $20bn shy of those expected in the US.

Another difference between Japan in the 1990s and the US today is the relative sizes of their economies. Japanese losses amounted to 15% of GDP reports the FT against about 7% of the US economy - making it about half the hit in GDP terms. And the third distinction says the IMF is again one of dispersion. Not only are subprime assets held around the world. They are held by a broad array of financial businesses. In 1990s Japan this was not the case. The Japanese banks bore the brunt of the losses. This time it’s not only the world’s banks, it’s the insurance companies, pension funds and hedge funds.

Commentary has alluded to the risk of the US following Japan into a deflationary slump. Do these distinctions make that less likely? We’re up to the question but regrettably not to the answer though it must help. As too should the cultural difference where loss of face in the West is not what it is in the East. History may show eventually that Bear Stearns was the bottom of the crisis but with some $230bn of losses revealed to date the credit squeeze is far from over. News abounds of its tightening grip around the necks of consumers who went too easy on EZ credit in pre-crunch days. Discrimination is making a comeback among the lending community as they look more closely at those credit reports.

Back to the IMF’s “Instability Report” for a moment. Comments from the IMF’s Head of monetary affairs and capital markets Jaime Caruana gives some insights.
- Since October “systemic risks have increased sharply” as has the potential domino effect if a large financial institution going bust.
- The Bear Stearns rescue “helped to reduce the possibility of a tail event in the financial system”. A what? The FT explains: ‘it made a truly catastrophic event less likely.’
- “Funding strains remain high and balance sheet pressures on financial institutions continue.”
- There has been a “collective failure to appreciate the extent of leverage in the financial system”.

Ah the old rogue steals centre stage in all the best financial crises. Borrowed money... Borrowed money to the max. You can amass the best brains, the best contacts and the best technology but still go bust. Long-Term Capital Management proved that in some style a decade ago now. Of the $129bn of assets it boasted at the time, $124.5bn had been purchased with borrowed money. Even a team that included joint economics Nobel prize winners Myron Scholes and Robert Merton couldn’t find a mathematical formula to save the ship when its mountainous debt hit an immovable object in the form of a Russian debt default inspired market panic. More recent examples of highly leveraged hedgies to have come unstuck in the current credit squeeze include Peloton Partners and Carlyle Capital.

As to the prospects for UK plc., the IMF is gloomy. It expects growth to be 1.6% this year and next. Okay I think we’ve all registered this is a slowdown for the UK. Here we’re just picking over how slow do we go. Alistair Darling is more optimistic. We’ll do better than that says he - 1.75% this year and 2.25% next. The metaphor of arranging deckchairs on a sinking Titanic comes to mind and we’re left hoping it is just that and ‘the further downside risks’ muttered darkly by some analysts don’t show up.

News on jobs and wage inflation provides some encouragement this morning. Permanent job placements picked up in March and wage inflation eased according to the Recruitment and Employment Federation/KPMG but the tone is cautious. Alan Nolan, a director of KPMG tells Reuters:
“No matter what sector, employers are becoming increasingly cautious about the outlook.”

It’s hard not to be cautious when even Sky News is headlining house price crash as its topic du jour and Gordon Brown is looking for scapegoats. As to that subject, we’ll give it a rest and let it our fevered brow cool for a while. That said it’s interesting to note HSBC is throwing UK homeowners a lifeline and possibly a support to the wider market. 1.4m mortgage holders face a rude awakening when they come off low fixed rate deals this year and start discovering the cost of money has gone up somewhat from the heady days prevailing a couple of years ago. But maybe this is an awakening postponed...

HSBC is offering to match homeowners’ existing deals – some as low as 4.54% - in what the FT calls “an audacious offer”. And quite possibly a shrewd one too for a UK bank with sufficient clout to take a view on the UK mortgage business. HSBC has 3% of the market and are building in a comfort zone on deals they will accept by demanding at least 20% property equity. Given there are 11.8m mortgages in the UK according to the Council of Mortgage Lenders, if HSBC captures even a quarter of this market segment it stands to at least double its market share at a time when weakened competitors are licking their wounds.

Whilst mentioning the Council of Mortgage Lenders, their press release yesterday is a timely reminder of the housing wealth held in Britain today. For all the angst, UK homeowners are collectively sitting on £2.5trn of housing wealth in hock to no one.

Over in the markets, European stocks are higher this morning with the FTSE 100 ten points clear of the 6,000 level. Mining giant BHP Billiton, currently bidding for Rio Tinto, is itself being stalked according to a report that broke in the Australian press. It was up nearly 5% yesterday on rumours that China’s Baoshan Iron and Steel is planning to pick up 9% of the company. Another Chinese entity Chinalco, has a 9% stake in Rio Tinto. It’s that West to East thing. Gold is lower at $908. Oil is $108. UK interbank lending rates are lower too, at 5.93%. The pound is worth $1.97 to the dollar and €1.25 to the euro.

Finally, today and tomorrow we are without Bill as he is somewhere in the Argentinean hinterland either travelling to or from his remote estancia in the foot hills of the Andes. Satellite communications permitting, he will return on Friday when we expect an update on the livestock included within his market reckonings. As a consequence, we run rather less verbose Reckonings today and tomorrow than is our habit.

Regards,
Rob Mackrill
The Daily Reckoning