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US sub-prime losses may reach $434b, says OECD

Organisation says worst is not over and credit turmoil could wreak more havoc on markets

LONDON – OVERALL losses caused by the United States mortgage market crisis could feasibly hit US$300 billion (S$434 billion), and the broader credit crunch could yet inflict greater damage on equity markets, the OECD said.

‘Thus far, equity investors seem to have shrugged off the negative sentiment that prevailed over the summer, but it may be too soon to draw firm conclusions,’ the Organisation for Economic Cooperation and Development (OECD) said in a report.

‘As adjustments have often occurred in waves, and as higher funding costs take typically several months to have their full impact on companies or consumers, it may well be that the recent correction is only a precursor of a more protracted downturn.’

Financial institutions and policymakers needed to buy time to ensure an orderly end to the trouble which spilled from the US mortgage sector to financial markets globally in July and August, the report said.

The OECD said the super fund being set up by Citigroup, Bank of America and JPMorgan Chase to pool securities of ailing special investment vehicles – thus preventing a further fire sale of these asset-backed securities – was a useful mechanism.

The Paris-based forum said the US housing market downturn had further to run and would continue to depress mortgage-linked debt held by banks, hedge funds and insurance firms.

‘We still have not hit the worst point in resets, delinquencies and ultimate losses on mortgages,’ the OECD said, adding that about US$890 billion of sub-prime mortgages, or poor credit quality loans, will have rates reset next year – and peaking in March.

The OECD report said a hypothetical 14 per cent loss rate on sub-prime mortgages being reset next year could deliver an overall US$125 billion hit to lenders.

Including Alt-A, or ‘near prime’, mortgages, cumulative losses in the US$200 billion to US$300 billion range ‘seem feasible’, it said.

The financial sector’s exposure to these losses lies mainly in holdings of mortgage-backed securities repackaged within complex collateralised debt obligations (CDOs) held by hedge funds, banks and bank-sponsored structured investment vehicles.

The OECD said hedge funds held 21 per cent, or US$650 billion, of riskier BB-rated and equity tranches of

CDOs. Banks held just 5 per cent, or US$150 billion, of these.

With mortgage-related assets constituting about 56 per cent of the backing for CDOs, the direct mortgage exposure in these investments could be reduced to US$360 billion for hedge funds and US$90 billion for banks.

Assuming the US$3 billion total CDOs outstanding has been cut over the past six months due to lower prices and asset restructuring, the US$200 billion to US$300 billion estimate of total losses due seems reasonable, the OECD said.

 

Source: REUTERS (The Straits Times 23 Nov 07)

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