June 15, 2008

More Credit Crunch Coming

Federal Reserve officials expect some U.S. banks to write down more assets while operating with insufficient reserves to cover bad loans, Vice Chairman Donald Kohn said. Credit will get tighter as lenders repair their balance sheets and loan only to the top tier.

According to Bloomberg, the collapse of the sub prime mortgage market has led banks and brokerages to report more than $386 billion in losses and write downs. Financial-services firms have raised $283 billion to cover the losses.

A stock market crash which can wipe out individual wealth is still paper wealth and doesnt necessarily transfer to the real economy. But a financial service industry crises affects the basis of economic activity and is far more devastating.

And the Beat Goes On....

MBIA and Ambac have just been downgraded from AAA to AA. So what, you ask. This is serious for our community development. When a city, county or state needs to buy more buses or upgrade sewer services or build schools upon voter approval the issue Municipal bonds (think of it as an IOU).

Many municipalities and states do not have a strong enough tax base to borrow at the best rates. The cost of higher interest can make or break a project. The work around has always been the bond insurers such as MBIA and Ambac. They will insure bonds that have less than AAA ratings. Effectively, for a small fee they could take a BBB rating community and wrap its AAA rating around that bond issue by insuring it for a small fee.

Viola, a BBB rated bond now can borrow at the lower AAA rates, thanks to the insurer and get the best interest rates available. Makes a project happen.

Thanks to the lower credit rating for the big bond insurers, the cost of borrowing for these communities has just gone up.

Warren Buffet, a brilliant investor and one of the richest men in the world notes: "We see a Baa credit enhanced to a Aaa credit by someone guaranteeing it for a 10-15 basis point charge. Yet, the spread in the market yield might be 100 basis points. Well, that doesn’t strike us as smart. … I would say that at some point, you can get into a lot of trouble at 140-to-1 insuring credits"

Its funny how what looked smart can turn on its head in a moment.

Howard Bell
A web site of over 450 articles related to real estate focused primarily on property management.

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