July 13, 2007

Fed officials move to soothe nerves over sub-prime debt

Mortgage woes unlikely to result in broader economic fallout, they say

WASHINGTON - OFFICIALS of the United States Federal Reserve did their best to calm worries that the ongoing troubles in the housing market and sub-prime lending sector will pose broader risks to the US economy and its financial system.

'The consequences of the declines in housing activity and prices, in my view, have so far not derailed the prospect that economic growth will return towards trend at the end of 2007 and in 2008,' Philadelphia Fed Bank president Charles Plosser said in remarks on Wednesday to the European Economics and Financial Centre.

He said the unwinding of the housing boom had led to a slower economy, but not to the bust that many had been forecasting.

He added that the paper losses that many home owners have experienced on their home equity 'are likely to have only a modest effect on their consumption patterns'.

Concerns about a possible fallout from the housing sector were renewed on Tuesday after two leading credit rating agencies started to slash ratings for more than US$17 billion (S$25.8 billion) in mortgage-related debt.

But Mr Plosser said: 'So far the financial system has not shown significant strains, although there certainly have been specific problems in some sectors, most notably the sub- prime loan market.'

Sub-prime loans are loans extended to borrowers with poor credit.

'The coming months should provide a better indication of the magnitude of any adverse effects from this sector,' Mr Plosser added.

Separately, Fed governor Kevin Warsh told a Congressional panel on Wednesday that investor losses from sub-prime mortgage delinquencies 'don't appear to be raising, to this point, systemic risk issues'.

Credit Suisse Group analysts this week estimated that investors have lost as much as US$52 billion amid the sell-off in the US$800 billion market for mortgage securities backed by sub-prime loans.

Some analysts said there were signs that investors were reassessing their attitude towards risk-taking in many asset classes.

The iTraxx Crossover index of derivatives on mainly junk-rated debt, a barometer of European corporate credit risk, rose sharply on Wednesday.

The cost of insuring 10 million euros (S$20.8 million) worth of this index against default jumped above 300,000 euros annually before subsiding to 295,000 euros, up 10 per cent on the day.

The US dollar at one stage on Wednesday fell to lows against the euro, sterling and yen. The Japanese currency typically strengthens as investors unwind carry trades and back away from risky assets. However, improving US stock markets helped the greenback to recover somewhat.

Said Mr Robert McAdie, global head of credit strategy at Barclays Capital, said: 'Volatility is going to be here to stay for a number of weeks.'

Wednesday's rally in US stocks prompted some investors to conclude that the turmoil in the credit markets was unlikely to spread much further.

JPMorgan observed that swings in derivatives prices were so extreme that they implied 'scenarios in which the core of the global liquidity system suffers a serious assault'.

But it stressed 'the meltdown in the credit indexes seems completely at odds' with trends in the real economy, implying that it should be reversed.