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A year of denial in US sub-prime crisis

It took months for a consensus that crisis would spread to the broader economy

(NEW YORK) One year after the first alarm bells of the sub-prime mortgage crisis rang in Wall Street, many of its victims are trading at half their value or less, while others have long been buried.

On Feb 8, 2007, HSBC said it would take a charge of about US$10.6 billion on sub-prime loans. The evening before, the No 2 US sub-prime lender, New Century Financial Corp, had unexpectedly warned it faced a quarterly loss and said it would restate previous earnings.

New Century shares lost more than a third of their value on Feb 8, but to look at the overall market, there was no telling how big a toll the crisis would take on the US stock market; the S&P 500 shed less than 2 points that day.

By spring, the stocks of sub-prime lenders were falling into a death spiral and dropped from the major exchanges in steady succession.

On April 2, New Century filed for bankruptcy protection.

American Home Mortgage Investment Corp followed in August.

Accredited Home Lenders Holding Co was bought out by a private equity firm in October.

Countrywide Financial Corp, the nation’s No 1 lender, hit a high of US$44.92 on Feb 7, 2007; the shares are now trading at US$6.58 as it awaits a takeover by Bank of America Corp.

But despite the bloodbath in the mortgage finance sector, investors last autumn were still confident enough that the sub-prime debacle was contained that they pushed both the Dow and S&P 500 to lifetime highs on Oct 11.

From its intraday high on Oct 11 to last Friday’s close, the S&P 500 index has fallen 15.5 per cent.

‘That’s been the history of the last year – denial, denial denial,’ said Gary Shilling, president of A Gary Shilling & Co, an investment research firm in Springfield, New Jersey. ‘That’s what held stocks up in October.’

That confidence was shaken shortly after, when Merrill Lynch warned it would have to write down billions of dollars more in sub-prime-related debt than it had previously said. Citigroup, Bear Stearns and others added to the writedown chorus.

In a year, Merrill Lynch has fallen nearly 45 per cent.

Citigroup stock has fallen more than 52 per cent and Bear Stearns has shed nearly 51 per cent. In addition to millions in market capitalisation, all three firms have lost their chief executives.

By New Year, consensus formed that the sub-prime crisis would indeed spread beyond the mortgage and financial market and into the broader economy, and potentially beyond US borders.

‘More recently, people realised the theory of decoupling was a fairytale, that the US really is the world’s economic leader,’ Mr Shilling said. ‘There’s still a lot of denial. The consensus is begrudgingly admitting we’re into or close to recession, but the consensus is now that it will be over in the first half of the year.’

Wall Street may have been late to recognise the impact of the sub-prime crisis, but the public caught on fast.

Less than a year after HSBC and New Century fired their warning flares, the television show Law and Order featured a plot about a con artist who scammed sub-prime mortgage holders facing foreclosure to sign over their homes.


Source: Reuters (Business Times 11 Feb 08)


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