Some folk might be wondering why so much attention is being paid to the subprime mortgage mess in the US: after all it's there and we are here in Australia, linked to booming China and away from the damage.
As we have seen that's a fallacy: over $1 billion in losses have been wracked up for local investors in the subprime mess, local interest rates have risen, takeovers and buyouts have failed, Rams Home Loans Group came close to failing and was dismembered and the good bits sold to Westpac, and the local stockmarket has taken a bit of a shaking from time to time from the ripples spreading from Wall Street.
Rams was in the news yesterday and so was a major funder, the National Australia Bank as the struggle to refinance $6.1 billion in loans looks like failing.
The credit squeeze is turning from a firm embrace into an uncomfortable hug.
News from the US and Britain (as well as the Rams statement here) was not good.
Some lenders will need to raise new capital and, even then, will have to take on less new business. Tighter conditions look set to continue and there is little that anyone can do to ease them.
On Tuesday, Freddie Mac, a repackager of home mortgages sponsored by the US government, revealed a $US 2billion third-quarter loss, and Paragon, a British mortgage company, announced that it was struggling to renew its financing facilities.
Freddie Mac shares fell 29% on Tuesday and another 6% yesterday.
Interbank lending rates have crept up again in recent weeks, including Australia.
The US Federal Reserve released its first ever set of forecasts and commentary on the US economy for the next three years and its overwhelmingly clear that the subprime mess and its associated credit crunch is the thing occupying the minds of the Fed, the most important economic policy and regulating group in the world economy.
The forecasts were released at the same time as the minutes of the October 31 meeting of the Fed's Open Markets Committee that cut rates.
The Fed cut its forecasts for US economic growth next year to a range of 1.8% to 2.7%, down from the June level of 2.5% to 2.7%. There's every chance the economy could slow sharply in the next few months if that forecast is to be followed.
From comments in the minutes and in the forecasts for next year, it is clear the Fed members are watching closely for something large enough to cause an "adverse shock" from the subprime mess, something big enough to badly damage sentiment in financial markets.
"Participants generally viewed financial markets as still fragile and were concerned that an adverse shock — such as a sharp deterioration in credit quality or disclosure of unusually large and unanticipated losses — could further dent investor confidence and significantly increase the downside risks to the economy,'' the minutes said.
So are a lot of other people in the markets. That's why there's enormous attention given to news of big write downs by financial groups.
We should remember an 'adverse shock' of the sort being watched for by the Fed would be large enough to cause shockwaves through the world because it would affect the American financial markets, and they are the one thing the rest of the world remains firmly attached to, and that includes China.
And an 'adverse shock' like that could damage the wider economy, which has so far withstood fairly well the hit from the subprime mess and August's credit crunch, which is now returning.
Since the rate cut on October 31, a rising number of US and European financial groups have revealed larger than expected write downs and losses on subprime mortgages and their associated credit derivatives. These have included UBS, Citigroup, Merrill Lynch, Bank of America, Washington Mutual and JP Morgan Chase.
US banking and finance stocks are down sharply this year: the likes of Citigroup and Merrill Lynch are staggering, crippled by a draining out of capital in the form of higher than expected losses. Both have given the Chairman and CEO the push.
Important as banks, mortgage lenders, and other financial groups for the health of the US mortgage industry, there are two quasi government organisations that are absolutely vital.
Fannie Mae and Freddie Mac are two US government-sponsored enterprises that help provide financing to the mortgage market. They buy mortgages, especially highly rated mortgages from the market: up to a limit of $US417,000.
The two companies were created by the US Congress decades ago to foster American home ownership. Their market cap is down $US41 billion so far this year
The companies, which guarantee 40% of the $US11.5 trillion American home loan market are vital to the state of the markets.
But both have reported third quarter results weak enough to raise questions about their immediate outlook and their ability to continue greasing the wheels of the housing industry.
Fannie Mae, the largest of the duo last week reported higher loses of almost $US1.4 billion but changed the way it measures and accounts for losses that produced a lower loss rate. However the previous accounting method would have produced a record loss rate on dud mortgages and now its shares are under pressure.
But yesterday shares of Freddie Mac plunged 29% after the company announced a $US2 billion quarterly loss and said it may have to cut its dividend due to concerns about its capital.
It caught the market by surprise and took the loss on the company's shares to more than 60%.
Investors were shocked by the news that Freddie Mac's capital surplus had fallen by $US1.2 billion, to only $US600 million above a mandatory target set under a consent decree with regulators several years ago in a settlement of a lending scandal.
The surplus fell because the value of its holding of mortgages
