US Banks 'set to foreclose and call in a swathe of loans'*

By Ambrose Evans-Pritchard
Last Updated: 7:25am BST 26/06/2007

The United States faces a severe credit crunch as mounting losses on
risky forms of debt catch up with the banks and force them to curb
lending and call in existing loans, according to a report by Lombard
Street Research.

Bear Stearns headquarters: Banks 'set to call in a swathe of loans'
Bear Stearns headquarters in New York

The group said the fast-moving crisis at two Bear Stearns hedge funds
had exposed the underlying rot in the US sub-prime mortgage market, and
the vast nexus of collateralised debt obligations known as CDOs.

"Excess liquidity in the global system will be slashed," it said.
"Banks' capital is about to be decimated, which will require calling in
a swathe of loans. This is going to aggravate the US hard landing."

Charles Dumas, the group's global strategist, said the failed auction of
assets seized from one of the Bear Stearns funds by Merrill Lynch had
revealed the dark secret of the CDO debt market. The sale had to be
called off after buyers took just $200m of the $850m mix.

"The banks were not prepared to bid over 85pc of face value for CDOs
rated "A" or better," he said.

"God knows how low the price would have dropped if they had kept on
going. We hear buyers were lobbing bids at just 30pc.

"We don't know what the value of this debt is because the investment
banks shut down the market in a cover-up so that nobody would know.
There is $750bn of dubious paper out there in the form of CDOs held by
banks that have a total capitalisation of $850bn."
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US property writer Paul Muolo described the Bearn Stearns crisis as the
“subprime Chernobyl”, saying the bank had created a “cone of silence”.

Abandoned by fellow banks, Bear Stearns has now put up $3.2bn of its own
money to rescue one of the funds, a quarter of its capital.

This is the biggest bail-out since the Long-Term Capital Management
crisis in 1998, which Bear Stearns refused to join at the time. Bear
Stearns is now alone, a case of rough justice being served.

Lombard Street’s warning comes as fresh data from the US National
Association of Realtors shows that the glut of unsold homes reached a
record of 8.9 months supply in May. Sales of existing homes slid to an
annual rate of 5.99m.

The median price fell for the 10th month in a row to $223,700, down
almost 14pc from its peak in April 2006. This is the steepest drop since
the 1930s.

The Mortgage Lender Implode-Meter that tracks the US housing markets
claims that 86 major lenders have gone bankrupt or shut their doors
since the crash began.

The latest are Aegis Lending, Oak Street Mortgage and The Mortgage
Warehouse.

“There isn’t a recovery about to happen,” said Ara Hovanian, head of the
building group Hovanian Enterprise.

Nouriel Roubini, economics professor at New York University, said there
were now concerns about “systemic risk fall-out” from the Bear Stearns
debacle as investors look more closely at the real value of CDOs.

“These highly illiquid securities have been priced so far on unrealistic
and distorted credit ratings as the ratings industry has been
complicit,” he said.

“They have not been rerated in a way that is consistent with rising
subprime default rates. “That is why Wall Street is in a panic. “Losses
will be massive once these assets are correctly priced to market.”

Lombard Street said the Bear Stearns fiasco was the tip of the iceberg.
The greatest risk lies in the “toxic tranches” of lower grade securities
held by the banks.

Much-trumpeted claims that banks had shifted off the riskiest credit
exposure on to the asset markets was “largely a fiction”, said Mr Dumas

. The worst of the US property crisis has yet to hit since there is an
overhang of $2,000bn of mortgages with adjustable rates which have yet
to be reset. Many borrowers could see payments jump by half, or even double.

At the same time, a spike in 10-year US bond yields by 0.65 percentage
points over the last six weeks has drastically repriced the cost of
fixed mortgages, knocking away a key prop for the US housing market.

“With defaults at their highest in the 37 years that records have been
kept, it could be a long hot summer,” said Mr Dumas.