||Last Updated: Dec 19th, 2007 - 13:17:15
Dr. Peter Morici: US Banks offer Plan to calm Credit Markets
By Professor Peter Morici, Robert H. Smith School of Business, University of Maryland
Oct 16, 2007, 16:37
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The creation by Citigroup, JP Morgan, and Bank of America of a special fund to purchase the collateralized debt obligations (CDOs) of major structured investment vehicles (SIVs) should be viewed as good news by the stock and bond markets.
| Dr Peter Morici |
Mortgage backed securities have significant intrinsic value that credit markets cannot reasonably assess but that are certainly present.
Most subprime mortgages will be repaid, either through refinancing or direct servicing. While some will fail, those notes have value, because servicing companies will resell the homes, albeit at discounted prices.After it has an opportunity to digest this news, the stock market should recovery from yesterday and today's adjustments, and stronger equity valuations should continue.
An inability to assess prospective default rates, thanks to imprudent initial bond ratings by Standard and Poor’s and others, make it difficult for bond buyers to accurately ascertain the liquidation value of CDOs.
If held to maturity, CDOs have a higher value than credit markets are attributing to them.
The creation of the Master Liquidity Enhancement Conduit is a constructive step toward avoiding fire sale losses and containing the damage to bank balance sheets posed by their SIVs, and this should serve to help stabilize credit markets.
Yesterday's announcement was dwarfed by Citigroup’s announced 57 percent drop in third quarter profits. However, the fact that banks are readily acknowledging the impacts of the credit crunch on the income statements and balance sheets should comfort stock and bond investors. We do not appear to be headed for another accounting crisis.
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