Good article on the spread of the liquidity crisis
September 5, 2007 11:47 a.m. EDT
Steel Says Uncertainty Has Spread
Beyond Subprime-Mortgage Sector
By DAMIAN PALETTA
September 5, 2007 11:47 a.m.
WASHINGTON — Uncertainty in how credit markets appraise risk has spread from the isolated subprime mortgage sector into much broader segments of the economy, such as securitized products and buy-out transactions, Treasury Department Under Secretary for Domestic Finance Robert K. Steel said Wednesday.
“Valuation became extremely difficult as a no-bid environment seized certain segments of the market,” Mr. Steel said in testimony to the House Financial Services Committee, according to prepared marks. “This reappraisal has spread across the credit market spectrum, first affecting residential-mortgage backed securities and then spreading to other asset classes and, particularly, securitized products.”
Mr. Steel called the risk reappraisal “normal” and said it “typically follows periods of widely available credit when markets have undervalued risk.”
This summer, credit markets froze in certain sectors as concerns grew about credit performance, exacerbated by growing problems in the performance of both subprime- and jumbo-mortgage products. Several large lenders scrambled to find liquidity. Federal Reserve, White House and Treasury Department officials have worked to calm the jittery markets with limited impact.
“I do want to caution policy-makers that this process is far from over,” Mr. Steel said. “It will take more time to play out and certain segments of the capital markets are stressed.”
Mr. Steel’s appearance at Wednesday’s hearing, alongside federal bank and securities officials, marked the first Congressional hearing on the matter since Congress returned from its August recess. He said the “ultimate impact of these events on the economy has yet to play out.”
Erik Sirri, director of market regulation at the Securities and Exchange Commission, said questions about credit and risk appraisal have had a broad impact on a wide range of participants.
“As liquidity for structured products diminished, market participants needing to raise funds to meet margin calls and investor redemptions sold less complex financial instruments such as equities and municipal securities, placing downward pressure on prices in those markets,” Mr. Sirri said. “Overall, these dynamics have significantly impacted a wide range of market participants, from individual investors to systemically important financial institutions.”
Mr. Steel, Federal Deposit Insurance Corp. Chairman Sheila Bair and Comptroller of the Currency John Dugan all said weakened underwriting standards fueled problems in mortgage markets as liquidity prompted lenders to develop new products.
“To satisfy…demand and their excess capacity, some mortgage originators relaxed their underwriting standards, lending to individuals with a lower standard of documentation and selling mortgage products, which for some borrowers would become unaffordable,” Mr. Steel said.
Mr. Dugan, whose agency supervises national banks, said the most severe credit market issues have occurred outside of the commercial banking sector.
“The national banking system remains safe and sound,” he said.
Mr. Dugan also said that the current strain on the banking system could end up having a positive impact as the industry reprices and reevaluates risk.
“While recent market conditions have certainly been painful, and may continue to be so for some time, we believe they are likely to cause some positive changes in the longer term as markets reevaluate and re-price risk,” he said.
Ms. Bair said the uneven mortgage industry standards created a dangerous backdrop that is now having a widespread impact.
The mortgage industry is overseen by a patchwork of state and federal regulators, which some Democrats in Congress are trying to overhaul this year.
“Failure to uphold uniform high standards in these areas across our increasingly diverse mortgage lending industry has resulted in serious adverse consequences for consumers, lenders, and, potentially, the U.S. economy,” Ms. Bair said. She said credit concerns have now extended to leveraged commercial lending.
Mr. Steel said Treasury officials shared the Fed’s view that “recent market developments pose downside risks to economic growth.” Still, he said the “underlying strength of the economy” should fuel further growth.
He said the President’s Working Group on Financial Markets planned to study the broad market issues related to recent market events, including the roles of securitization and the credit rating agencies.
Mr. Steel said the U.S. Department of Housing and Urban Development planned to propose new settlement procedures this fall, a process that the agency has long struggled to finalize because of harsh turf battles between different industries involved in the mortgage closing process.
Mr. Sirri said issues in the subprime and credit markets have prompted the SEC to begin a review of the credit rating agencies services, potential conflicts of interests, disclosures, and rating performance, among other things.
