Sub-Prime Losses Gnaw At Recovery’s Roots

LOSSES ARE RISING in Britain’s residential mortgage market and pushing ‘non-conforming’ [sub-prime] mortgage-backed securities into a downward slide that is likely to get worse, Moody’s Investors Service said today.

The Reuter’s report continues:-

‘The delinquencies and losses continue to rise at a rapid pace as unemployment continues to rise,’ said Nitesh Shah, an economist and one of the authors of the report.

‘Moody’s expects further performance deterioration in the near future for non-conforming RMBS,’ he said.

Moody’s said that in 54 non-conforming transactions, more than 20% of underlying loans were delinquent by more than 90 days, out of a total of 88 outstanding deals worth £27.3 billion.

Six transactions fully depleted their reserve funds in the second quarter, Moody’s said — and when reserve funds are depleted, losses go the note-holders.

When the government cut the Bank of England’s base rate to its historic low of 0.5%, it inevitably gave a breathing space to those with ‘non-conforming’ mortgages in the UK. But those people, generally on low incomes, have been hardest hit in this recession — seeing their incomes drop further or losing their jobs altogether. The base rate cut enabled them to hold-on to their properties a little longer; but it could not prevent the inevitable from happening.

In the above report, those ‘noteholders’ are, generally speaking, the banks and building societies that actually provided the funds for low-income families to purchase their properties. But, because mortgage deals are generally profitable (by virtue of charging interest) those notes became valuable commodities in themselves — particularly when the credit rating agencies decided to give them a triple-A rating (inferring they carried no risk).

Once they had a AAA rating, the banks then insured themselves against the risk of having borrowers default on their arrangements — and a whole new market was born. Financial institutions began trading the notes worldwide, and we now have a situation where nobody really knows who is holding what.

All we can be sure of is that the notes are basically worthless and that, at some stage, the insurance industry is going to be inundated with claims from note-holders to reimburse their losses. Claims that could find that industry devoid of sufficient funds to meet their obligations (but without the ability to call upon the Government for help; because Labour has already spent the funds bailing-out the banks).

In another report out today, the Press Association’s headline said: ‘UK’s economic prospects “worsening”.’

Prospects for the UK have worsened while other nations begin an earlier than expected recovery from recession, an economic body has warned.

The Organisation for Economic Co-operation and Development (OECD) said the UK economy would shrink by 4.7% this year — worse than its 4.3% forecast in June.

Its UK verdict is far below the 3.5% decline predicted by the Treasury, and contrasts with the improved prospects for other major nations compared with the OECD’s last round of forecasts.

The OECD said developments had been ‘mostly favourable’ in recent months although headwinds such as high unemployment and house price falls meant the recovery was ‘likely to be modest for some time to come.’

‘Modest’ is the worrying factor. The UK economy needs to recover to a position in which a large amount of debt has been paid off, before it can ever hope to prevent another financial meltdown when the insurance industry is called upon to bail-out those ‘non-conforming’ note-holders.

It may not be this month; it may not be this year; but another financial crisis is inevitable. Moody’s report is particularly worrying; because it has revealed the tip of the iceberg sooner than many predicted — and the government, this time, is in no position to help…

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3 Responses

  1. And the problem is that economic recovery will simply serve to exacerbate the situation and make matters still worse.

    As the economy improves the billions spent by the government on quantatitive easing and propping up the banks balance sheets will begin to flood the economy. Interest rates will have to rise to contain inflationary pressures, mortgage rates will go up, sub prime borrowers will fail to keep up payments, the public housing stock will come under extreme pressure, house prices will plummet as more and more properties are sold by lenders (at a substantial loss) and those notes underwriters are going to be drained of funds.

    Not a bad position for the banks though (who have always wanted to be in the insurance/underwriting business). And guess who has got all the money to bail the insurance industry out?

    The banks can sit back and smile at any losses they take on those notes and look foreward to the day when they can at last takeover the insurance industry

    • Yes. Cynical observers (forgive me) would say that was the intention all along. They just didn’t have the conditions necessary for a successful raid or the liquid funds to pull it off. So they got together with the credit rating agencies; sold the underwriters a dummy, and calmly sat back and waited.

      Persuading the government to give them all that money (instead of just offering to subsidise increased saving rates to attract more funds and solve their liquidity problem) must have been the icing on the cake.

      One good thing should come out of this though, Cynical: the housing bubble will finally burst. (When all those properties start hitting the market, house building will have again picked-up).

      • Yes, and that is why when that new building begins the emphasis needs to be on social housing.

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