One Key Market Likes The Bailout Plan
By GREGORY ZUCKERMAN
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Global stock and credit markets have shrugged off the U.S. government's plan to buy $700 billion of troubled debt. But the scheme is showing some signs of success in the market that sparked the wildfire: bonds built out of subprime-mortgage loans.
The awkwardly named 2006-01 ABX index tracking AA-rated mortgage-backed bonds is up 13% in the past three weeks to 57.4. The higher the number, the lower the perceived risk of default on the bonds. Indexes tracking subprime mortgage-backed bonds rated AAA and BBB are up almost 10%, even as many other markets have collapsed.
Despite criticism that the ABX is manipulated by hedge funds or fails to represent the overall subprime or housing markets, the index did a good job anticipating the current crisis when it collapsed in early 2007. The rally raises a glimmer of hope in the ongoing housing bust.
Behind the rally is excitement that the government soon will buy mounds of troubled mortgage debt. Some investors also are enthusiastic about recent data indicating that the rate of increase in subprime delinquencies is slowing - although they already represent about 40% of outstanding loans.
The rate of decline in housing prices also has been slowing. Some investors who made billions anticipating the collapse of the housing market, such as John Paulson, put on their trades when housing price increases started to slow two years ago. If the rate of decline is slowing, it might mean a bottom is getting closer.
However, investors shouldn't get carried away. If unemployment continues to rise as expected, the creditworthiness of all types of borrowers will likely weaken. And the credit crisis is forcing lenders to be less accommodating of those hoping to refinance high-rate subprime loans.
Higher-risk borrowers usually feel more pain in the fourth quarter, as heating costs climb and holiday bills pile up. Meanwhile, even as delinquencies slow, actual default rates are increasing.
Perhaps the biggest concern: interest-rate resets on mortgages. Rate cuts by the Federal Reserve earlier this year allowed many subprime borrowers to avoid a jump in payments when the rate on their loans reset. But the recent increase in Libor rates soon will cause pain.
At current Libor levels, the rates on $150 billion of subprime mortgages will jump by 1.5 percentage points or more when they reset for the first time over the next nine months, according to Vipul Jain, a strategist at Bank of America. Others will face higher rates when they encounter an additional reset to their loans.
As long as housing prices are declining, even if they're falling at a slower pace, it will crimp householder net worth, push more homes into foreclosure and pressure the economy. Signs of life in the subprime-mortgage market are encouraging. But valuations were already at rock bottom. The patient is not ready to get off the sick bed. |
