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Foreign love for U.S. assets at risk in subprime drop
By Jennifer Ablan
Wednesday, March 14, 2007
NEW YORK -- The deepest housing decline in 16 years could slow an inflow of global capital that has more than funded the massive fiscal and external deficits in the United States.
For years overseas investors have been buyers of American corporate debt, mortgage-backed securities and agency bonds at record pace, helping cover the U.S. current-account deficit -- the broadest measure of international transactions.
But the rapid unraveling of the U.S. subprime mortgage industry, which is stirring new concerns about the already weak housing market, could change all of that.
"The mounting losses in U.S. subprime mortgages and the rising home (loan) delinquencies would likely find foreigners losing their taste for dollar assets in general," said Stephanie Pomboy, an economist and financial analyst at MacroMavens in New York.
A change in foreign tastes would be disruptive since the insatiable hunt for yield has led foreigners to U.S. collateralized debt obligations. These pools of debt assets such as subprime mortgages have boomed amid the global liquidity glut.
And as Greg Peters, head of U.S. credit research at Morgan Stanley, puts it, foreigners have become "big" purchasers of these products in recent years.
In fact, banks doubled the amount of CDOs outstanding in the past two years to $2.6 trillion, including a record $769 billion sold last year, according to JPMorgan Chase & Co. These figures include funded and unfunded issuance.
"Securitized consumer debt like ABS and MBS have been the Gatorade quenching the global thirst for yield," added Pomboy, referring to asset-backed and mortgage-backed securities.
Figuring how much juice foreigners put to work in these CDOs and collateralized loan obligations or other exotic derivatives is difficult to pin down, said Peters and Pomboy.
U.S. Treasury data show in 2006 that 81 percent of net foreign inflows were in so-called agency debt sold by Fannie Mae and Freddie Mac and U.S. corporate bonds, which include ABS and MBS. These are securities that are packaged in CDOs.
Those staggering inflows into the credit markets could slow, however.
Lehman Brothers estimate that the total market for subprime-related CDOs has lost about $18 billion to $23 billion of its value owing to the recent widening in subprime subordinates and ABS CDOs.
"We think investors and speculators are getting out of existing positions to preserve capital until the dust settles," Marc Chandler, global head of currency at Brown Brothers Harriman, wrote in a report.
"While we aren't suggesting we're clearly at the end of this move, we do think the corrections, while large for a few weeks, are relatively small given the magnitude of the (big price) moves over the past year or so."
Even so, investors and strategists remain worried over a risk of reallocation of assets from the U.S. market.
Were that to happen, it would greatly complicate the task of financing America's current-account deficit, which at $856.7 billion in 2006 was a record 6.5 percent of gross domestic product. That's up from 1.7 percent of GDP a decade ago.
In dollar terms, that means the U.S. needs to attract $3 billion to $4 billion per day to balance its payments. If it fails to, the dollar will weaken over time, potentially driving up inflation and interest rates.
For now, those needs largely have been met by foreign purchases of U.S. securities. In 2006, net foreign acquisition of long-term securities totaled $730.4 billion, 4.5 percent higher than the previous year. Meanwhile, the broadest gauge, monthly net Treasury International Capital inflows, totaled $827.9 billion, up 24 percent from the previous year.
Trouble is brewing in one area of the credit markets: Lower-quality, lower-tier quality U.S. assets, said Michael Cosgrove, proprietor of The Econoclast, a monthly analysis of the economy and financial markets.
The subprime crisis "would reduce foreigners' appetite for lower-quality U.S. corporate debt -- and push them into higher-quality U.S. debt."
If his forecast is right then interest rates on lower-quality corporate bonds and ABS and MBS would continue to rise. But government bonds would gain, without the need for the dollar to fall dramatically to induce foreigner investors to purchase U.S. assets, he said.
"There is a lack of alternatives outside the U.S. and foreigners would most likely move money into U.S. Treasuries," he said. "Since the '90s Asian contagion, the U.S. is still considered the prime market."
At the very least, that should bring some relief amidst the fallout in the subprime market.
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