Fed chief acknowledges credit fears/Fed chief says subprime losses could hit $100bn/Bernanke sees little threat of credit crunch
Fed chief acknowledges credit fears
By Krishna Guha in Washington and Richard Beales, Michael MacKenzie and Saskia Scholtes in New York
Copyright The Financial Times Limited 2007
Published: July 18 2007 18:47 | Last updated: July 19 2007 01:34
Ben Bernanke acknowledged for the first time on Wednesday that credit concerns were spreading beyond the subprime mortgage market as investors showed their worries with a flight to quality, seeking refuge in government bonds and other safe assets.
Although the Federal Reserve chairman played down the likely effect on the US economy, declaring that financial conditions remained “generally favourable”, US Treasury yields fell sharply following the release of his testimony to Congress. Ten-year notes were yielding 5.02 per cent – 2 basis points down on the day – after dipping below 5 per cent.
Mr Bernanke said the Fed had trimmed its central tendency forecasts for growth this year and next, but made no change to its forecasts for inflation.
Investors were already shaken by news that two Bear Stearns-managed hedge funds that had invested in subprime loans were nearly worthless. Weak earnings reports added to the day’s gloom. On Wall Street, the S&P 500 index closed down 0.2 per cent, following a day of losses across most of Asia and Europe.
The jitters also boosted S&P 500 volatility with the Chicago Board Options Exchange Vix index closing up 2.3 per cent at 16.0.
Derivative indices tracking corporate credit risk on both sides of the Atlantic rose across the board. The dollar weakened, with the New York Board of Trade dollar index falling to a 15-year low during the day.
Mr Bernanke said conditions in the subprime mortgage sector had “deteriorated significantly” and noted “increased concerns among investors about credit risk on some other types of financial instruments”.
But he said “even after their recent rise...credit spreads remain near the low end of their historical ranges” and added that business financing activity “remained fairly brisk”.
The reduction in the Fed’s growth forecasts reflect a more protracted drag from housing investment, as well as a weak first quarter. They suggest that the Fed now thinks the economy is unlikely to return to its trend rate of growth until some time next year.
The lack of a change in the inflation forecasts, meanwhile, underlines policymakers’ reluctance to put much store on the recent decline in core inflation.
However, the Fed’s basic story was unchanged. It still expects growth to remain at a “moderate pace” while the housing adjustment proceeds, before returning to about trend as the drag from housing fades. Inflation is expected to moderate very slowly, with a slight rise in unemployment.
While noting that housing woes posed a downside risk to the outlook, Mr Bernanke said there was also a risk that consumer spending could bounce back more strongly than expected.
He emphasised that the Fed had “consistently stated that upside risks to inflation are its predominant policy concern”. Mr Bernanke highlighted the high rate of headline inflation, as well as the lower rate of core inflation excluding food and energy.
“Bernanke has acknowledged that the subprime situation is an issue and it is spreading,” said Richard Gilhooly, a strategist at BNP Paribas. But Gerald Lucas, senior investment advisor at Deutsche Bank, said subprime problems were primarily a threat to the financial sector.
Fed chief says subprime losses could hit $100bn
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: July 19 2007 16:02 | Last updated: July 19 2007 16:02
Total losses from the subprime mortgage meltdown may be in the order of $50bn to $100bn, according to estimates cited by Ben Bernanke in testimony to Congress on Thursday.
The Fed chairman said:”There clearly will be some significant financial losses associated with defaults and delinquencies on these mortgages.”
Mr Bernanke also cautioned Congress against legislating narrowly on China’s exchange rate, rather than addressing this in combination with the need for structural reform.
He said the exchange rate was ”not a subsidy in the legal sense” but rather the cause of distortions in the Chinese economy that channel resources towards exports rather than production for domestic demand.
Bernanke sees little threat of credit crunch
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: July 19 2007 01:42 | Last updated: July 19 2007 01:42
The agitation in financial markets on Wednesday contrasted sharply with the largely benign and little-changed economic outlook laid out by Ben Bernanke in his testimony to Congress.
Mr Bernanke made clear that the Fed does not see the tightening of credit conditions to date as severe enough to have macro-economic implications.
The US central bank did shave its “central tendency” forecasts for growth a fraction this year and next but this simply reflected the mathematical effect of a more protracted drag from residential investment.
The Fed appears increasingly confident that the rest of the economy is in robust shape and both consumer spending and business invest ment will expand at a “moderate pace” in the coming quarters.
Mr Bernanke did admit for the first time that credit concerns have spread beyond the subprime mortgage market. But he said credit spreads are still low by historical standards and financing activity remains brisk.
With equity prices up strongly since the start of the year and the dollar down – offsetting the contractionary effect of higher credit spreads – financial conditions generally remain “supportive of economic growth”.
His assessment suggests the Fed sees no immediate threat of a broad credit crunch. Indeed the central bank is probably happy to see investors pull back a little from what had been extraordinary levels of risk appetite and demand slightly higher prices for risk, slightly lower levels of leverage in some deals and tighter covenants on some loans.
Nor will the Fed be troubled by swings in asset prices so far. With no evidence of outright panic, denial of liquidity or forced selling, financial markets appear to be working well.
Nonetheless, Mr Bernanke and his colleagues know that this could change quickly and will monitor developments carefully. In all probability, the subprime drama is not yet fully played out.
Headline-grabbing news of losses suffered by particular financial institutions to some extent represent the allocation of losses the Fed knew were in the system.
But the lags involved in marking to market and the likelihood of waves of credit downgrades mean there is still a risk of a downward spiral, in which troubled investors are forced to liquidate their holdings because of tougher margin requirements, putting more downward pressure on the market.
The Bear Stearns case is reassuring in so far as it showed that painful losses can be absorbed by the system, without threatening the supply of credit to businesses and consumers. But it is troubling in so far as it showed that even sophisticated investors could fail to hedge properly and be left holding derivative products so complex no potential buyer could figure out whether they had any value.
The Fed will focus as ever on the health of systemically important financial institutions. Their total exposure to subprime does not appear large relative to their capital. This remains the case even when you add exposure to bridging finance on private equity deals – particularly since sponsors with future deals to finance are likely to allow some repricing. But the Fed will pay attention to the rise in the cost of credit default swaps that insure against default by major financial institutions – a signal that there is concern about their exposure to credit and volatility more generally.
Fed officials know that financial crises can occur without any obvious deterioration in economic fundamentals – as they did in 1987 and 1998. However, they will be relieved that credit repricing is occurring now – when the downside risks to growth seem to have receded – and not a few months ago, when the risk of a downturn in the economy and accompanying rise in defaults loomed much larger.
By Krishna Guha in Washington and Richard Beales, Michael MacKenzie and Saskia Scholtes in New York
Copyright The Financial Times Limited 2007
Published: July 18 2007 18:47 | Last updated: July 19 2007 01:34
Ben Bernanke acknowledged for the first time on Wednesday that credit concerns were spreading beyond the subprime mortgage market as investors showed their worries with a flight to quality, seeking refuge in government bonds and other safe assets.
Although the Federal Reserve chairman played down the likely effect on the US economy, declaring that financial conditions remained “generally favourable”, US Treasury yields fell sharply following the release of his testimony to Congress. Ten-year notes were yielding 5.02 per cent – 2 basis points down on the day – after dipping below 5 per cent.
Mr Bernanke said the Fed had trimmed its central tendency forecasts for growth this year and next, but made no change to its forecasts for inflation.
Investors were already shaken by news that two Bear Stearns-managed hedge funds that had invested in subprime loans were nearly worthless. Weak earnings reports added to the day’s gloom. On Wall Street, the S&P 500 index closed down 0.2 per cent, following a day of losses across most of Asia and Europe.
The jitters also boosted S&P 500 volatility with the Chicago Board Options Exchange Vix index closing up 2.3 per cent at 16.0.
Derivative indices tracking corporate credit risk on both sides of the Atlantic rose across the board. The dollar weakened, with the New York Board of Trade dollar index falling to a 15-year low during the day.
Mr Bernanke said conditions in the subprime mortgage sector had “deteriorated significantly” and noted “increased concerns among investors about credit risk on some other types of financial instruments”.
But he said “even after their recent rise...credit spreads remain near the low end of their historical ranges” and added that business financing activity “remained fairly brisk”.
The reduction in the Fed’s growth forecasts reflect a more protracted drag from housing investment, as well as a weak first quarter. They suggest that the Fed now thinks the economy is unlikely to return to its trend rate of growth until some time next year.
The lack of a change in the inflation forecasts, meanwhile, underlines policymakers’ reluctance to put much store on the recent decline in core inflation.
However, the Fed’s basic story was unchanged. It still expects growth to remain at a “moderate pace” while the housing adjustment proceeds, before returning to about trend as the drag from housing fades. Inflation is expected to moderate very slowly, with a slight rise in unemployment.
While noting that housing woes posed a downside risk to the outlook, Mr Bernanke said there was also a risk that consumer spending could bounce back more strongly than expected.
He emphasised that the Fed had “consistently stated that upside risks to inflation are its predominant policy concern”. Mr Bernanke highlighted the high rate of headline inflation, as well as the lower rate of core inflation excluding food and energy.
“Bernanke has acknowledged that the subprime situation is an issue and it is spreading,” said Richard Gilhooly, a strategist at BNP Paribas. But Gerald Lucas, senior investment advisor at Deutsche Bank, said subprime problems were primarily a threat to the financial sector.
Fed chief says subprime losses could hit $100bn
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: July 19 2007 16:02 | Last updated: July 19 2007 16:02
Total losses from the subprime mortgage meltdown may be in the order of $50bn to $100bn, according to estimates cited by Ben Bernanke in testimony to Congress on Thursday.
The Fed chairman said:”There clearly will be some significant financial losses associated with defaults and delinquencies on these mortgages.”
Mr Bernanke also cautioned Congress against legislating narrowly on China’s exchange rate, rather than addressing this in combination with the need for structural reform.
He said the exchange rate was ”not a subsidy in the legal sense” but rather the cause of distortions in the Chinese economy that channel resources towards exports rather than production for domestic demand.
Bernanke sees little threat of credit crunch
By Krishna Guha in Washington
Copyright The Financial Times Limited 2007
Published: July 19 2007 01:42 | Last updated: July 19 2007 01:42
The agitation in financial markets on Wednesday contrasted sharply with the largely benign and little-changed economic outlook laid out by Ben Bernanke in his testimony to Congress.
Mr Bernanke made clear that the Fed does not see the tightening of credit conditions to date as severe enough to have macro-economic implications.
The US central bank did shave its “central tendency” forecasts for growth a fraction this year and next but this simply reflected the mathematical effect of a more protracted drag from residential investment.
The Fed appears increasingly confident that the rest of the economy is in robust shape and both consumer spending and business invest ment will expand at a “moderate pace” in the coming quarters.
Mr Bernanke did admit for the first time that credit concerns have spread beyond the subprime mortgage market. But he said credit spreads are still low by historical standards and financing activity remains brisk.
With equity prices up strongly since the start of the year and the dollar down – offsetting the contractionary effect of higher credit spreads – financial conditions generally remain “supportive of economic growth”.
His assessment suggests the Fed sees no immediate threat of a broad credit crunch. Indeed the central bank is probably happy to see investors pull back a little from what had been extraordinary levels of risk appetite and demand slightly higher prices for risk, slightly lower levels of leverage in some deals and tighter covenants on some loans.
Nor will the Fed be troubled by swings in asset prices so far. With no evidence of outright panic, denial of liquidity or forced selling, financial markets appear to be working well.
Nonetheless, Mr Bernanke and his colleagues know that this could change quickly and will monitor developments carefully. In all probability, the subprime drama is not yet fully played out.
Headline-grabbing news of losses suffered by particular financial institutions to some extent represent the allocation of losses the Fed knew were in the system.
But the lags involved in marking to market and the likelihood of waves of credit downgrades mean there is still a risk of a downward spiral, in which troubled investors are forced to liquidate their holdings because of tougher margin requirements, putting more downward pressure on the market.
The Bear Stearns case is reassuring in so far as it showed that painful losses can be absorbed by the system, without threatening the supply of credit to businesses and consumers. But it is troubling in so far as it showed that even sophisticated investors could fail to hedge properly and be left holding derivative products so complex no potential buyer could figure out whether they had any value.
The Fed will focus as ever on the health of systemically important financial institutions. Their total exposure to subprime does not appear large relative to their capital. This remains the case even when you add exposure to bridging finance on private equity deals – particularly since sponsors with future deals to finance are likely to allow some repricing. But the Fed will pay attention to the rise in the cost of credit default swaps that insure against default by major financial institutions – a signal that there is concern about their exposure to credit and volatility more generally.
Fed officials know that financial crises can occur without any obvious deterioration in economic fundamentals – as they did in 1987 and 1998. However, they will be relieved that credit repricing is occurring now – when the downside risks to growth seem to have receded – and not a few months ago, when the risk of a downturn in the economy and accompanying rise in defaults loomed much larger.
posted by Carlos T Mock at 8:46 AM
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