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| Henry "Hank" Paulson responds to President George W. Bush Tuesday, May 30, 2006, after the President announced the nomination of the Chairman and Chief Executive Officer of the Goldman Sachs Group as US Treasury Secretary. |
US Treasury Secretary Hank Paulson warned on Tuesday that “there aren’t any easy answers” to the current subprime linked credit turmoil. In Berlin, Federal Reserve Chairman Ben Bernanke said that the increasing appetite for investment in developed nations was putting upward pressure on global real interest rates.
“What’s going on is a repricing of risk across the capital markets,” Hank Paulson told reporters Tuesday, at a breakfast held by The Christian Science Monitor in Washington. “This is something in my judgment that will take a while to work through.”
He said the uncertainty in the credit markets would last longer than the turmoil that followed the Asian crisis and the Russian default of 1998 or the Latin American debt crisis of the 1980s.
In Brussels, Jean-Claude Trichet, European Central Bank President, said in remarks to a committee of the European Parliament, that it was time for global financial authorities to tackle unregulated entities whose activities had contributed to the latest upheavals.
The comments coincided with news that credit ratings agencies have been called to a special meeting in Washington by the body for the world’s securities regulators to explain how they rate structured financial products based on mortgage assets.
Paulson pointed to the difficulties of financial services companies in valuing complex assets tainted by mortgage-backed securities.
“The reason it is going to take longer today [than in previous crises] is that we are more globalised,” he said. US mortgages had been “sliced and diced” and were turning up at Landesbanken – State-owned regional banks in Germany.
“Secondly, it is the level of complexity,” he said, adding that he had met daily with bankers trying to value asset-backed commercial paper and other products.
“When they are confident they understand the products, confidence will return,” he said.
The uncertainty over valuing subprime mortgages could last for up to two years as many of the loans, which were agreed at so-called "teaser" discounted rates are due for reset to higher rates.
In London, the problems for the markets in dealing with asset-back commercial paper (ABCP) was illustrated by a rise in the three-month Libor -London interbank offered rate, on Tuesday, to 6.9037% - a nine-year high.
Defaults among US companies with speculative-grade credit are likely to triple over the next year, underscoring the recent weakness in the debt markets, Moody's Investors Service said Tuesday.
"We think the era of easy access to credit has ended," said Daniel Gates, Moody's chief credit officer for corporate finance in North America said
The default rate is expected to rise from 1.4 percent in 2007 to 4.5 percent in 2008 and 5.6 percent in 2009, according to Moody's projections. Default rates would likely climb even higher if the economy were to go into recession, Gates said.
A 4 percent default rate is consistent with historical averages. During the most recent downturn in the cycle, default rates reached 11 percent in January 2002.
The rise in long-term real interest rates around the world over the past three years appears to be the result of increasing appetite for investment in developed nations and not any diminution of the “global savings glut” that originates in the developing world, Ben Bernanke said in Berlin on Tuesday.
The Federal Reserve Chairman said surplus savings in developing nations should gradually diminish in the future, putting further upward pressure on global real interest rates.
Bernanke's comments were made when giving the 2007 Bundesbank Lecture.
He said that real interest rates have reversed some of their previous declines, in recent years. For example, in the United States, real yields on inflation-indexed government debt averaged 2.3% in 2006 as compared with 1.85% in 2004. In the past few weeks, that yield has averaged about 2.4%. Inflation-adjusted yields in other industrial countries have also started to move back up after falling in 2005
Bernanke said “the logic of the global savings glut” suggested that as the net supply of financial capital from emerging markets declined, “real interest rates should rise” -a tendency that would probably only be “partly offset” by higher saving in industrial countries.
However, he described this process as taking place over a “few decades” rather than a shorter time frame.
The call for a special meeting with the rating agencies and the International Organisation of Securities Commissions, follows criticism of the way the agencies have issued overly positive opinions on the creditworthiness of mortgage-related securities that were based on underlying assets now in severe distress due to the subprime meltdown. They point to the fact that the rating agencies, are often paid by the issuers of such securities.
Iosco this year completed a review of a “code of conduct” issued to credit rating agencies in 2004.
Philippe Richard, Iosco secretary-general, told the Financial Times: “In helping structure the products, the agencies are usually involved from the beginning in the ratings process. We identified a potential problem there that we want to further analyse.”
Richard said Iosco had since March been co-ordinating with the Committee on the Global Financial System – which monitors developments in financial markets for central bank governors of the G10 countries – on a fresh effort to study credit ratings agencies.
In response, Chris Atkins, Standard & Poor’s vice-president of communications for Standard & Poor’s, said: ”We do not structure transactions. Our criteria are publicly available, non-negotiable and consistently applied. We do not rate financial instruments that don’t meet our criteria.”
