World markets swooned again yesterday as Countrywide, the largest U.S. mortgage lender, edged toward insolvency and Moody’s, Wall Street’s top credit agency, warned of hedge-fund collapses on a scale not seen since the 1998 world financial meltdown.
The Dow Jones Industrial Average fell as much as 343 points amid record trading yesterday to 10 percent below its record high of 14,001, prompting the Federal Reserve to provide $17 billion more of cash infusions. U.S. markets mostly recovered after the Fed’s moves, with the Dow closing down 16 points, in part because of rampant speculation that the panic on Wall Street soon will force the central bank to cut interest rates.
Countrywide Financial Corp. signaled a heightened state of financial distress by drawing down an $11.5 billion bank line of credit as it continues to have difficulty raising funding for mortgages in the debt markets. While banks have access to emergency loans from the Fed, Countrywide is mostly dependent on markets for funding and is thus considered the most vulnerable major lender to the ongoing credit crunch. Countrywide owns a bank and said it is shifting the bulk of its mortgage production to the bank and will henceforth provide only high-quality loans that can be easily sold to Fannie Mae or Freddie Mac.
The bankruptcy of another large home lender, American Home Mortgage, has left D.C. home buyers scheduled to close on mortgages totaling $3 million this month in the lurch, the District’s banking office said yesterday as it issued a cease-and-desist order prohibiting the company from doing further business in the city.
With the repercussions of the credit crunch sweeping the globe and causing a downdraft in world stock and bond markets, Moody’s Investors Service said the conditions are ripe for the failure of a major hedge fund like the collapse of Long Term Capital Management in 1998 — a spectacular demise that forced the Fed to arrange a bailout and come to the rescue of the markets with deep rate cuts.
“We’ve seen quite a bit of contagion over the past two weeks, and it doesn’t seem to be abating,” said Chris Mahoney, vice chairman of Moody’s, who also predicted significant losses at banks and the failure of many more minor investment funds in the next three to six months.
French President Nicolas Sarkozy called for tighter regulation of hedge funds, which are allowed to move secretly and invisibly in financial markets despite their enormous size and potential for disruption, as well as an investigation into the role that credit agencies like Moody’s played in creating the opaque market for mortgages that is imploding and threatening growth around the world.
“Freedom is not the law of the jungle,” he told a French radio station. “We cannot go on like this, with some hedge funds borrowing at any price, lending to anyone, without us knowing to whom, and we not knowing who undertakes the risk in the end.”
France’s top bank, BNP Paribas, has been one of the biggest victims of the subprime mortgage meltdown. The bank triggered the latest round of turmoil last week by announcing it was freezing redemptions from subprime mortgage funds.
The spreading turmoil in global financial markets has prompted Mr. Sarkozy and political leaders around the world to urge confidence in the face of the panic. Yesterday, London’s FTSE stock index fell more than 4 percent in its biggest loss since 2003, and indexes elsewhere around the world lost between 2 percent and 4 percent.
The Bush administration has portrayed the stock drubbing mostly as a necessary correction, however, as markets adjust to the heightened risks inherent in many mortgage securities, stocks and other investments. The Fed also has said the repricing of risk was overdue and has expressed little concern about the impact of tightening credit conditions on the broader economy, despite widespread expectations on Wall Street that it will be forced into action within days or weeks.
Recent economic reports have portrayed a generally healthy economy during July, before the worst of the market rout.
A Commerce Department report yesterday showed, however, that even before the current credit crunch hit mortgage markets, housing construction plummeted 6.1 percent to the lowest levels in a decade.
William Poole, president of the St. Louis district Fed bank, yesterday said he is not convinced the economy is endangered by the credit crunch and the central bank shouldn’t consider cutting interest rates before its next meeting on Sept. 18 unless a “calamity” occurs. His statement prompted many on Wall Street to speculate that the possible demise of Countrywide would be the sort of “calamity” that would force the Fed off the sidelines.
Some market commentators say the doomsday predictions are exaggerated.
“The current sell-off is a much-needed correction to excesses in the credit markets,” said Dan Chung, chief executive of Alger Management Co., adding such downturns are typical in the middle of economic and bull market cycles. “As the smoke clears, investors will find solid fundamentals underpinning both the global economy and numerous companies.”
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