Credit Trends Show Growing Anxiety, Longer Crisis

Friday, June 27, 2008 4:16 PM

NEW YORK -- The credit crunch that threatened to unravel the world's financial system earlier this year has reasserted itself with surprising force this week.

Global credit markets that supply money for everything from home mortgages to businesses and municipal projects are warning that a credit crunch is back in full swing. Credit spreads, a measure of financial stability, are widening sharply, defaults are on the rise, and potential borrowers are finding high costs and unwilling lenders.

Mortgage debt, corporate bond and other credit metrics in the United States and Europe are at the weakest levels in months, and junk bond sales are off to their worst start since 2000, when a slump in deals signaled the last U.S. recession.

"People don't know if this will go on for months or if it's a five-year issue," said Greg Habeeb, portfolio manager at Calvert Asset Management in Bethesda, Maryland, where he helps oversee about $9 billion. "I don't think the end happens soon, and no one knows if this is a multi-year problem."

Such sentiments reflect a stark increase in uncertainty about the outlook since April, when executives, including Richard Fuld of Lehman Brothers said the worst was over.

Investor confidence is wilting once again, threatening more market upheaval. Even efforts by central banks to provide billions of dollars in financing have not shored up confidence of investors or capital-constrained banks, which continue to unload even relatively safe assets from balance sheets.

Adding to woes, the central banks which flooded the markets with unprecedented amounts of cash and credit lines to unlock frozen credit are themselves less willing to lower rates further for fear of fanning inflation.

Subprime mortgage bonds that sparked the crisis a year ago plunged again, with some indexes hitting record lows as reports showed greater delinquencies. Economists forecast waves of additional defaults and steeper declines in home prices as risky mortgages backfire on the banks that financed them.

U.S. high-yield bonds similarly have weakened, as junk bond sales this year plummeted 69 percent to $29.1 billion, according to Thomson Reuters data, the lowest level since the first six months of 2000. That decline in sales was a precursor to the last U.S. recession from March to November 2001.

In Japan, a banking crisis in the 1990s led to a so-called "lost decade" of growth, after an asset bubble ballooned between 1986 and about 1990. Some analysts fear a similar malaise from the current crisis.

The widely watched iTraxx Europe index broke the 100-basis-point barrier this week for the first time since April, a sign of increasing risk aversion on worries that banks will report more write-downs and losses.

On Friday, European stocks slumped to their lowest level since October 2005, while U.S. stocks fell, pushing the Dow Jones industrial average into bear market territory for the first time since 2001.

Efforts in the United States to keep home mortgages from going bad, whether it be federal legislation or industry efforts, are failing to shore up the confidence of investors who increasingly believe the market cannot avoid a painful catharsis.

"We are in the midst of a credit and liquidity crisis," said Jim Sarni, a money manager at Los Angeles-based Payden & Rygel, which invests more than $50 billion. The markets are "driven by people's fears and perceptions, and human nature. That perception has changed from one that thinks things will be all right."

ANNIVERSARY

One year after the credit crisis hit, global banks have reported more than $400 billion in write-downs and losses, and the figures keep climbing. Oil prices also have soared to a record $142 a barrel. Now corporate bankruptcy risk is rising and inflationary fears threaten to crimp consumer spending and prolong the U.S. housing and global credit crises.

Measures by world central banks and the U.S. Federal Reserve to increase capital availability to the market have so far failed to right financial markets, according to JP Morgan. Investors have begun to lose hope.

"It is hard to imagine from where the next 'savior' will appear," JPMorgan analyst Eric Beinstein co-wrote in a report on Friday. "The Fed, the Treasury, Congress, and overseas investors have all stepped in at various points over the past year."

The result has been "an anemic U.S. economy, high commodity prices, the looming threat of inflation, and little to rescue the market but the time required to let the cycle play out," JPMorgan's report said.

Figures released this week on subprime loans hardened bears. Traders increased bets against the most-battered sector after reports showed delinquencies for risky mortgages made in 2006 climbed 1.5 percentage points in May to nearly one in every four loans. The ABX-HE 06-2 subprime index tracking the "AAA"-rated slices of subprime mortgage-backed bonds fell to within 3 points of its record low of 66.1 this week through Thursday, down 18 percent from May, according to Markit.

Lower-rated portions of that index never got a breath of life in May and are bumping along just above zero.

Wall Street dealers are partly to blame for the turn in credit markets, pulling back on trading of risky mortgage bonds after signaling a willingness to support markets in May, a Boston-based fund manager said. Without transparent dealer pricing, the rudderless market will only deteriorate, he said.

Even the $4.5 trillion market for mortgage bonds backed by Fannie Mae and Freddie Mac has erased half its rally from May, despite purchases by the mortgage giants themselves. Yields on Fannie Mae MBS paying 6 percent interest have jumped to as high as 1.85 percentage point more than benchmark Treasuries, the highest premium since March 27.

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