Fallout From Credit Crunch Creates Another One

Parts of the market for packages of loans are functioning reasonably well; almost none were in August. Now buyers and sellers are both at the table. However, investors have concluded that many debt securities are riskier than they thought then, and they are requiring higher interest rates as compensation.

And it's not only in the troubled home mortgage sector. For example, packages of high-quality loans for office buildings and other commercial properties had interest rates 0.7 percentage points higher than comparable Treasury bonds earlier this year, according to a Morgan Stanley index for commercial mortgage-backed securities.

During the August credit crunch, that premium rose to 1.5 percentage points before dropping in September and early October. But yesterday, investors required an interest rate premium of 1.7 percentage points to take on the risk of lending for commercial real estate.

"People are looking at things and saying, 'Hey, I'm going to price the market according to what I expect will happen, not what I currently see happening,' " said Alan Todd, head of commercial mortgage-backed securities at J.P. Morgan, who noted that delinquencies on commercial mortgages are starting to pick up from historic lows.

Another example of the spreading sense of worry: Wall Street is closely watching the rash of bad news from bond insurers, who guaranteed complicated securities that are now going bad in portfolios across the globe.

"Will they be able to pay up on the claims as these defaults and foreclosures roll in on the underlying mortgages?" said Ed Rombach, senior derivatives analyst at Thomson Financial. "If they can't, there's going to be hell to pay. It's going to lead to a whole new round of downgrades of these securities. Those downgrades will lead to a whole new round of write-offs for Citigroup and investment banks and commercial banks and hedge funds."

Yesterday, insurance giant Swiss Reinsurance took a $1 billion write-down of losses on complicated securities tied to home mortgages, another example of how the problems tied to the U.S. housing market have spread widely and unpredictably -- and of how companies are still coming to terms with the scope of the losses.

Economists speak of "tail risks," meaning events that are unlikely to happen but would cause major disturbances if they did. And in recent weeks, many analysts think that the likelihood of these risks, while low, has risen.

Laurence H. Meyer, a former Federal Reserve governor, described three such risks in a note to clients of his forecasting firm, Macroeconomic Advisers. A major financial institution could fail or come close to failing. Government-sponsored housing-finance companies Fannie Mae and Freddie Mac could find they are more exposed to the mortgage problems than investors have factored into their stock and bond prices. And the market could lose faith in the companies that insure debt against credit losses.

"The general point is that the current circumstances are marked by sizable loses on credit positions, with no one quite sure of what the eventual magnitude of those losses will be or where they are located," Meyer wrote. "That raises the possibility of financial markets becoming more turbulent."

Tse reported from New York.