Subprime fallout: Who's stuck with $400 billion in losses?
How asset-backed securities tied to risky mortgages and US consumer debt are affecting investors around the world.
from the February 25, 2008 edition
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Usually these foreign investors were seeking a higher yield for their money than offered by supersafe US Treasury bonds. With US consumers and companies buying massive amounts of foreign goods each year, many foreign institutions had billions of dollars to invest in some way or another. Packages of mortgages on American houses put together by Wall Street seemed like a good opportunity since home prices were rising steadily and the packages were blessed by rating agencies.
These agencies earned extra fees to examine them, but Williamson doubts they were influenced by these fees to "deliberately misrepresent" the safety of these investments. But, he adds, "they didn't ask difficult enough questions" of the Wall Street investment banks selling the packages.
In any case, Standard & Poor's president Deven Shama announced Feb. 7 that the company was strengthening its ratings process. The two other key agencies, Moody's and Fitch, also have unveiled new methodologies and standards for rating financial products.
So far, various financial institutions in the US and abroad have announced some $120 billion in losses from these investments.
But the big question in the financial community is: Who holds the remaining $280 billion of toxic waste? (The $400 billion estimate minus the $120 billion in announced losses.)
Those holding it are reluctant to admit it, says David Wyss, chief economist at Standard & Poor's in New York
"The only people who tell us are the people who have to tell us," he says. "We don't know where the rest of it is."
Disclosure laws require US banks to reveal losses. But the disclosure requirements abroad are often less strict than US rules. "There is a lack of transparency," Mr. Wyss says.
A bad-investment breakdown
To get a better idea of who owns the bad investments tied to the battered US real estate market, follow the CMO. That's shorthand for "collateralized mortgage obligation." Basically, CMOs are packages of mortgages on American houses put together by Wall Street investment banks.
In the US, hedge fund managers generally talk about their holdings of financial "toxic waste," such as CMOs, only if they suffer severe losses and go out of business. Pension-fund CMO losses may only show up in periodic public reports.
Deborah Lucas, an economist at Northwestern University in Evanston, Ill., and another economist, Joseph Haubrich, did a study last summer of CMO holdings worldwide for the Federal Reserve Bank of Cleveland. Using somewhat shaky data for year-end 2003, they calculated a total of $709 billion in CMO issues. Of that total, $182 billion were owned by foreign investors. US commercial banks held $263 billion, life-insurance companies $155 billion, and smaller amounts were held by other financial institutions. Since 2003, billions more in CMOs have been sold. And that is just one bunch among the various classes of asset-backed securities that have shaken world markets.
Of course, financial troubles are not new to the world. In the 1970s and '80s, US banks were stung by defaults after investing billions in "petrodollar" deposits from the oil-rich Middle East into Latin America. The Asian financial crisis of 1997-98 also cost foreign investors a lot of money.
In the meantime, more and more owners of CMOs and other "toxic waste" are suing the issuers of those debt instruments, charging basically that they were misled.
To Professor Lucas, it's all part of the way the game is played. Investors who want international diversification and higher yields, she says, should anticipate "unexpected losses."
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