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Risk of mortgage securities fire sale mounts

Section: Daily Dispatches

By David Wighton, Saskia Scholtes, and Gillian Tett
Financial Times, London
Tuesday, November 6, 2007

The risk of fire sales of mortgage-backed securities was rising on Tuesday after rating downgrades pushed a clutch of complex debt vehicles into default, threatening a further escalation of the turmoil caused by the subprime mortgage meltdown.

The prospect of forced sales comes as a US Treasury-backed plan for a "superfund" to buy up distressed mortgage securities appears to have stalled.

Rating agencies Standard & Poor's and Moody’s have received default notices for $5 billion worth of the vehicles, known as collateralised debt obligations, giving holders of senior debt the right to sell assets.

"The senior controlling class will typically want to get the hell out and pay themselves back, even if that means selling the underlying securities at a discount," said Arturo Cifuentes, managing director at fixed-income broker RW Pressprich and a former Moody’s analyst.

The threat of forced sales of mortgage-backed assets has prompted the US Treasury to back the proposal by three top US banks to set up for a $75 billion superfund to buy securities from cash-strapped structured investment vehicles.

However, the plan has fallen badly behind schedule with no other banks yet making a firm commitment to join Citigroup, Bank of America and JPMorgan Chase.

Executives at other banks believe the plan has been hurt by the turmoil at Citigroup, which lost its chief executive, Chuck Prince, on Sunday after admitting it faced further mortgage-related writedowns of up to $11 billion.

"As far as we can see, it appears dead in the water right now," said one senior Wall Street banker.

However, one person close to the plan said progress had been made on deciding what assets would be eligible and syndication of the back-up bank lines was set to start late next week.

Some observers fear it might now prove impossible to create the superfund quickly enough to help banks deal with the funding problems dogging SIVs -- off-balance sheet entities that use short-term debt to fund longer-dated investments.

Expectations are rising that banks might be forced to provide more help to the SIVs they manage in the coming weeks, to prevent a forced sale of their assets.

Citi, which manages SIVs with about $80 billion of assets, had bought $7.6 billion of commercial paper issued by its SIVs by October 31, out of a total commitment of $10 billion, it disclosed in its quarterly filing with regulators.

Morgan Stanley shares dropped another 2 per cent on Tuesday, for a fall of 20 per cent over the past week, as David Trone, analyst at Fox-Pitt Kelton, said it could face another $6 billion of mortgage-related writedowns.

Goldman Sachs again denied rumours that it was about to announce big writedowns.

Mounting investor concern about writedowns of mortgage securities is raising expectations that the Federal Reserve will have to cut interest rates to stop the credit market turmoil from tipping the US economy into a sharp downturn.

These worries helped drive the dollar to new lows against the euro. In turn, this spurred gold prices to jump to a 28-year high and oil to surge above $97 a barrel.

Investors also have been worried about the health of US bond insurers, such as MBIA and Ambac, whose central role in the capital markets depends on their high credit ratings.

However, Ambac and MBIA yesterday rose 13 per cent and 7 per cent, respectively, after Ambac and FGIC, another credit insurer, issued statements ­reaffirming their financial strength.

Fitch, the rating agency, warned on Monday that it was reviewing the capital adequacy of the companies to assess whether their AAA ratings were still justified.

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