Financial Times Editorial Comment: Subprime grenades
Financial Times Editorial Comment: Subprime grenades
Copyright The Financial Times Limited 2007
Published: July 31 2007 18:28 | Last updated: July 31 2007 18:28
Little debt market bombs are starting to explode on the balance sheets of financial institutions around the world. In the space of a couple of days, $3bn Boston hedge fund Sowood Capital has shut itself down after losing more than 50 per cent of its capital, while a parcel of subprime debt has blown up in the face of IKB, a German bank. These losses are rather encouraging.
They are encouraging because the pain is dispersed, spread among institutions of different kinds in different countries and buffered by those institutions’ capital. That makes a contagion, where losses at Fund A mean it cannot service its loans from Bank B, which in turn calls in debts from Company C, unlikely, and should prevent the current, healthy repricing of risky assets from turning into a crisis.
So far new tools for transferring risk such as credit default swaps, which insure investors against a company going bankrupt, seem to have done a good job of spreading risks from subprime borrowers and leveraged buy-outs far and wide. That should make the financial system more resilient than it has been during credit wobbles in the past.
One negative consequence is that losses will pop up in funny places, such as at the IKB Deutsche Industriebank, a specialist lender to the German Mittelstand. Further surprises are likely – at a Japanese credit union, perhaps, or a small insurer in the US Midwest – and it may turn out that some investors did not really understand they were buying bonds backed by subprime mortgages. No financial institution, however, should be criticised for trying to diversify its credit risk.
The current credit problems could yet get worse if more loans default. If prime US mortgage borrowers started to miss payments, or a lot more companies went bust, then losses could get so high that no amount of diversification would prevent a serious financial crisis.
But that looks unlikely to happen. The world economy is strong – unusually so – and the US is not in bad shape. Gross domestic product grew at an annualised rate of 3.4 per cent in the second quarter of 2007 and the labour market is tight. Growth in important Asian economies such as China and India is almost too fast for comfort and until economic conditions start to change, the chances of a severe deterioration in underlying credit quality are low.
None of which will make investors in Sowood Capital or the ousted chief executive of IKB any happier. Innovation may have made the financial markets more resilient as a whole, but for individual investors it is now even easier to lose a lot of money, and lose it fast.
Copyright The Financial Times Limited 2007
Published: July 31 2007 18:28 | Last updated: July 31 2007 18:28
Little debt market bombs are starting to explode on the balance sheets of financial institutions around the world. In the space of a couple of days, $3bn Boston hedge fund Sowood Capital has shut itself down after losing more than 50 per cent of its capital, while a parcel of subprime debt has blown up in the face of IKB, a German bank. These losses are rather encouraging.
They are encouraging because the pain is dispersed, spread among institutions of different kinds in different countries and buffered by those institutions’ capital. That makes a contagion, where losses at Fund A mean it cannot service its loans from Bank B, which in turn calls in debts from Company C, unlikely, and should prevent the current, healthy repricing of risky assets from turning into a crisis.
So far new tools for transferring risk such as credit default swaps, which insure investors against a company going bankrupt, seem to have done a good job of spreading risks from subprime borrowers and leveraged buy-outs far and wide. That should make the financial system more resilient than it has been during credit wobbles in the past.
One negative consequence is that losses will pop up in funny places, such as at the IKB Deutsche Industriebank, a specialist lender to the German Mittelstand. Further surprises are likely – at a Japanese credit union, perhaps, or a small insurer in the US Midwest – and it may turn out that some investors did not really understand they were buying bonds backed by subprime mortgages. No financial institution, however, should be criticised for trying to diversify its credit risk.
The current credit problems could yet get worse if more loans default. If prime US mortgage borrowers started to miss payments, or a lot more companies went bust, then losses could get so high that no amount of diversification would prevent a serious financial crisis.
But that looks unlikely to happen. The world economy is strong – unusually so – and the US is not in bad shape. Gross domestic product grew at an annualised rate of 3.4 per cent in the second quarter of 2007 and the labour market is tight. Growth in important Asian economies such as China and India is almost too fast for comfort and until economic conditions start to change, the chances of a severe deterioration in underlying credit quality are low.
None of which will make investors in Sowood Capital or the ousted chief executive of IKB any happier. Innovation may have made the financial markets more resilient as a whole, but for individual investors it is now even easier to lose a lot of money, and lose it fast.
posted by Carlos T Mock @ 6:41 AM
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