U.S. subprime default fears roil markets but manageable

By Herbert Lash - Analysis

NEW YORK (Reuters) - How big is the problem in the U.S. subprime mortgage market and to what extent will it slow economic growth?

This is the question haunting investors as mortgage market losses made their way onto bank and hedge fund balance sheets in recent weeks, forcing central banks to inject cash into banking systems to calm fears of a global credit squeeze as liquidity evaporated.

The losses from investments in U.S. subprime mortgages will be quantifiable eventually, but many are securitized and held in collateralized debt obligations (CDOs) whose terms add another unknown to investors calculations in the short term.

"Nobody quite knows how much equity valuation is at risk here because it's on the books of a lot of less-than-transparent investment vehicles," said David Joy, market strategist at RiverSource Investments, a unit of Ameriprise Financial Inc.

"And so you don't really know just what the potential is for a loss."

Estimates of losses on subprime mortgages range from $55 billion to as much as $100 billion, but the difficulty in assessing the damage is partly responsible for the indiscriminate selling of bond and stocks, Joy said.

"This is in my mind evidence of the fact that investors are overly nervous precisely because of the unknown," said Joy, who oversees about $157 billion in assets. Joy added the fears are unfounded and that investor confidence will eventually return.

Jitters over the size and location of subprime mortgage related losses roiled markets anew on Thursday after France's biggest listed bank, BNP Paribas, froze 1.6 billion euros ($2.2 billion) worth of funds that invested in subprime mortgages.

Major central banks, including the Federal Reserve, have injected at least $323.3 billion into credit markets since Thursday to prevent them from seizing up.

Last week investment bank Credit Suisse estimated total defaults in the subprime mortgage market to be about $200 billion on some $1 trillion of outstanding loans. After recovery efforts, losses might be reduced to about $100 billion, Credit Suisse said.

HighMark Capital Management Inc. pegged potential losses over five years at $55 billion.

"We just wanted to put a fence around what we think is the possible economic loss that subprime and Alt A would create," said David Goerz, who oversees about $20 billion in assets as chief investment officer at HighMark.

As the estimated value of investments, based on mark-to-market or mark-to-model valuations, has fallen in recent weeks, some investors have been asked to put up additional capital to support leveraged investments, but that does not necessarily mean investors are sitting on big losses, Goerz said.

The subprime component, about 10 percent of the overall $10 trillion U.S. mortgage market, is still healthy though because of the huge gains in home values over the last five to seven years, he said. Home prices would need to fall 30 percent or more on many mortgages before bonds would be impaired, Goerz said.

"Because the price of the security has fallen doesn't mean the underlying collateral is actually not substantial enough to cover the bond," he said. "That's the important point in all this."