Market Shock_ AAA Rating May Be Junk - New York Times
Click here to load reader
-
Upload
supriya-kumar -
Category
Documents
-
view
215 -
download
0
Transcript of Market Shock_ AAA Rating May Be Junk - New York Times
7/30/2019 Market Shock_ AAA Rating May Be Junk - New York Times
http://slidepdf.com/reader/full/market-shock-aaa-rating-may-be-junk-new-york-times 1/2
31/10/08 7:38 AMMarket Shock: AAA Rating May Be Junk - New York Times
Page 1 of 2http://select.nytimes.com/2007/07/20/business/20norris.html?pagewanted=print
July 20, 2007
HIGH & LOW FINANCE
Market Shock: AAA Rating May Be Junk By FLOYD NORRIS
The great stock market rally of 2002 through 2007 has been built on liquidity — and much of
the liquidity has been based on financial engineering that allowed highly risky investments to
be financed by investors who thought they were taking no risks.
They were wrong.
Now the question is whether the market can continue rising as investors learn that the financial
innovations that helped to build the boom were constructed on sand.
When Bear Stearns admitted this week that two hedge funds were expected to lose, in round
numbers, 100 percent of their value, it blamed “unprecedented declines in the valuations of a
number of highly rated (AA and AAA) securities.”
Those securities were nothing like the bonds issued by companies with triple-A or double-A
ratings. Such bonds almost never plunge in value because the companies borrowing the money
are financially solid.
But the money invested by the hedge funds went to finance mortgage loans to subprime
customers, borrowers as close to being a triple-A credit as Moscow is to Maui as a beach resort.
By the magic of securitization, sow’s ears could become silk purses, or at least look like them.
Most subprime mortgages would never default, went the theory, and rising home prices would
minimize losses when there were defaults. So if a security was protected from the first 10 or 20
percent of losses in a mortgage portfolio, then it was as safe as a loan to General Electric. Such
securities got AAA ratings.
Securities with a greater exposure to loss could still get in vestment-grade ratings. All told, the
vast majority of the money that financed risky loans appeared to be invested in investment-
grade paper.
Those who made the mortgage loans — or who made junk-rated loans to leveraged buyout
companies — found that they could securitize the loans and sell the highly rated securities for
enough money to assure themselves a profit before any homeowners could default. Any profit
that came later from the riskier securities, which the lenders often kept, was icing on the cake.
The buyers of this supposedly safe paper in the subprime mortgage market are now suffering
not so much because of the defaults that have already occurred but because of the defaults that
7/30/2019 Market Shock_ AAA Rating May Be Junk - New York Times
http://slidepdf.com/reader/full/market-shock-aaa-rating-may-be-junk-new-york-times 2/2
31/10/08 7:38 AMMarket Shock: AAA Rating May Be Junk - New York Times
Page 2 of 2http://select.nytimes.com/2007/07/20/business/20norris.html?pagewanted=print
investors fear.
The rating agencies are threatening to downgrade some AAA-rated paper, and there is rising
nervousness about bonds issued by companies like MBIA and Ambac that guaranteed some of
those AAA securities. The shares of a smaller insurer, ACA Capital, have lost half their value in
a few weeks. An index of shares in six financial insurers has lost a tenth of its value since the
end of May.
For stock market investors, the important question is whether a chain reaction will follow.
Investors are already backing away from securitizations of packages of subprime mortgages,
making such mortgages more difficult to obtain.
At a minimum, it seems likely that securitizations to finance junk corporate loans will be
harder to put together, and that buyers will demand higher yields on even the supposedly safe
parts of them. That will make leveraged buyouts more expensive.
This week the Dow Jones industrial average traded above 14,000 for the first time, and the
Standard & Poor’s 500 traded at more than double the low it reached in the fall of 2002. It is
clear that many stock buyers think troubles in the securitization market are of no concern to
them.
In his Congressional testimony this week, Ben S. Bernanke, the Federal Reserve chairman,
said, “Credit spreads on lower-quality corporate debt have widened somewhat, and terms for
some leveraged business loans have tightened.”
But, he added, “Credit spreads remain near the low end of their historical ranges, and financing
activity in the bond and business loan markets has remained fairly brisk.”
He is right, at least so far. But if those who are putting up the money for all those risky loans
conclude that there is a lot of risk — despite the magic of securitization and despite reassuring
ratings from the bond-rating agencies — that could change. And such a change would be very
bad news for stock market investors who expect to have their companies acquired in the private
equity boom.
Copyright 2007 The New York Times Company
Privacy Policy Search Corrections RSS First Look Help Contact Us Work for Us Site Map