Aversion to Risk Deepens Credit Woes

By FLOYD NORRIS
The credit markets came under renewed stress Thursday as investors sought absolute safety and even moved away from debt issued by Fannie Mae and Freddie Mac, the government-sponsored mortgage lending enterprises.
The intensifying credit crisis came as one regulator, Timothy F. Geithner, the president of the Federal Reserve Bank of New York, said that some banks had moved from being too willing to take on risks to being reluctant to take any chance of losing money, a move that was making the crisis worse.
“The rational actions taken by even the strongest financial institutions to reduce exposure to future losses have caused significant collateral damage to market functioning,” Mr. Geithner said in a speech to the Council on Foreign Relations. “This, in turn, has intensified the liquidity problems for a wide range of bank and nonbank financial institutions.”
Those liquidity problems intensified Thursday as a new increase in the number of mortgage foreclosures was reported and two financial companies that had relied on borrowed money said they were unable to raise the cash demanded by their lenders.
Both Carlyle Capital, a company sponsored by the Carlyle Group, a major private equity fund, and Thornburg Mortgage, the second-largest independent mortgage lender in the United States after Countrywide, said they had been unable to meet the demands and had defaulted on some obligations. Their stock prices plunged.
The credit market jitters were blamed for a sharp drop in stock prices, with the Standard & Poor’s 500-stock index falling 2.2 percent. Financial stocks were the hardest hit, with an index of such shares falling to its lowest level in more than four years. Fannie Mae shares fell $2.57, or 10.6 percent, to $21.70, and Freddie Mac shares dropped $1.50, or 6.7 percent, to $20.14. Both are at their lowest level in more than a decade.
As the economy grew through most of this decade, much of the growth was fueled by borrowing, both by individuals taking out mortgages and by investors who sought high returns through highly leveraged investments. Some of those investments are now unraveling because lenders will not lend enough money to enable investors to hold on to them. That reluctance forces the sale of investments, which lowers prices and makes lenders even less willing to risk their capital.
“Leverage is acceptable in a stable economic environment, but not in an economic crisis,” Geraud Charpin, a strategist at UBS, wrote last week.
At the end of last year, Carlyle Capital had $21.76 billion in assets, of which $21.69 billion had been pledged as collateral against loans. It had borrowed $31 for every dollar of equity, and even a $150 million line of credit from its parent, the Carlyle Group, was not enough to keep it out of trouble as lenders demanded more collateral to back up their loans.
Fannie Mae and Freddie Mac, whose debt has been viewed as almost as safe as that of the government itself, have played an essential role in keeping the mortgage markets functioning. That is because many mortgage companies have gone out of business and investors have been unwilling to buy mortgage-backed securities unless the government, or one of the enterprises, guaranteed the mortgages.
The difference between the yield on long-term debt guaranteed by Fannie Mae and that of similar Treasury debt rose to its largest level in more than 20 years, providing a new sign of the nervousness that has affected financial markets.
In Congressional testimony, William B. Shear, an official with the Government Accountability Office, warned that Fannie and Freddie, “with more than $6 trillion in outstanding obligations,” could pose “significant risks to taxpayers” if they ran into difficulty.
Each of the two enterprises has a $2.25 billion line of credit with the Treasury, but that is a small fraction of what they owe. Mr. Shear said it was “generally assumed on Wall Street that assistance would be provided in a financial emergency.”
With the trading levels indicating that some traders were no longer as confident of that assumption as they had been, rumors swirled that the Treasury Department was preparing to issue an explicit guarantee of the debts of government-sponsored enterprises, or G.S.E.’s, to calm the market. A Treasury spokeswoman denied those rumors.
“The rumor of an explicit government guarantee for the G.S.E.’s speaks to the gravity of the current situation,” said Margaret Kerins, a strategist at RBS Greenwich Capital.
The index of yields on Fannie Mae guaranteed loans rose to 5.96 percent on Thursday, an increase of 13 basis points from the previous day. (A basis point is one-hundredth of a percentage point.) At the same time, the yield on 10-year Treasury bonds fell 9 basis points, to 3.58 percent.
The difference in the two yields, of 2.38 percentage points, was the largest since 1986 and was more than twice the difference of a year ago, before credit fears began to grow.
The credit crisis began last year with indications of rising defaults on subprime mortgage loans, a problem that bankers and regulators said could be easily contained. But it gradually spread as confidence declined in the financial engineering that has remade the financial system in recent years.
The bond rating agencies have been forced to reduce the ratings on some structured finance products — many of them ultimately backed by mortgage loans — from AAA to very low levels. That has damaged the credibility of the agencies at the same time that it has made investors wary of taking on any risk.
Many of those structured finance products had been guaranteed by bond insurers like MBIA and Ambac, and the fact that they could face significant claims has led to concerns about their solvency.
An effort to bail out Ambac with guarantees from banks foundered on the reluctance of banks to commit capital they might need for other purposes, and a plan announced Wednesday for the company to raise additional capital by selling stock was greeted with hostility by investors, causing its share price to lose nearly a third of its already depressed value in the last two days.
Concerns have also grown about a recession, with economists forecasting an increase in the unemployment rate when February’s job figures are released Friday. On Thursday, the Federal Reserve reported that the net worth of households fell in the first quarter, the first time that had happened since 2002.
The Mortgage Bankers Association reported that the proportion of borrowers more than 30 days delinquent rose to 5.82 percent, the highest since 1985. The situation was worst among subprime borrowers who had taken out adjustable rate mortgages, but the proportion of prime mortgages that were delinquent also rose, to 3.24 percent.