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Funny, we used to ask, who owns my note? Now look...

Uncertainty fouls financial markets
Who’s got the bad loans?
By Jay Fitzgerald | Monday, January 14, 2008 | | Business & Markets
Boston Federal Reserve President Eric Rosengren is probably too diplomatic to put it so bluntly.

But others aren’t as shy: “It’s the uncertainty, stupid.”

Reports last week that Merrill Lynch this week will likely report a $15 billion write-down for its mortgage holdings - a figure far higher than previously anticipated - caught Wall Street off guard and sent stocks on another tumble that reflects growing anxiety about a possible recession in the wings.

But the problem facing the financial markets is not the overall size of the mortgage-related debacle that’s now squeezing financial giants such as Merrill Lynch, Citigroup, Bear Stearns, Wells Fargo and others, economists say.

The scale of the entire mortgage crisis, which includes a combination of troubled subprime and standard mortgages that were sold off as securities in the secondary markets is roughly $300 billion, or about the size of the savings and loan crisis that challenged the economy in the 1990s, said David Wyss, chief economist at Standard & Poors in New York.

The real problem, Wyss and others say, is that no one quite knows who is holding those bad securities after they were sold off to investors - and which financial institutions ultimately backed them up. Merrill Lynch’s surprise $15 billion write-down - after weeks of other investment houses reporting their own huge write-downs - merely reflects the uncertainty of who’s holding what in a complicated global economy, economists say.

“People are afraid to loan to anyone,” said Wyss, noting the financial markets may remain semi-paralyzed until matters become more clear. It really has caused the financial market to freeze up.

The mortgage-related products could ultimately be held by hedge funds, investment banks, college endowment and public pension funds, and many others. It’s that uncertainty that’s harming the financial system and further damaging an economy already shaken by the housing slowdown, high energy prices and weak jobs growth, economists say.

“The good news is the risk (of the mortgage products) has been spread around to many investors,” said Nariman Behravesh, chief economist at Global Insight, a Lexington economic research firm. “The bad news is that we don’t know where all of the risks are.”

Rosengren said that lack of “transparency” is a major problem facing the financial markets and economy today.

In speeches last week in Connecticut and Vermont, Rosengren noted the differences between the real-estate crisis in New England in the early 1990s and the real-estate woes that hit Japan during the same time period.

In New England, the real-estate downturn was brutal and scores of banks failed as bad residential and commercial real-estate loans took their toll.

But at least banks and regulators knew what institutions held those loans - and the markets quickly punished the vulnerable, paving the way for a relatively fast real-estate and financial recovery later in the decade, Rosengren said.

In contrast, Japan’s banks and regulators effectively papered over the massive commercial and residential real-estate losses, leading to a long decade of confusion and stagnation, Rosengren said.

“This lack of transparency and disclosure made many investors . . . wary of Japanese financial institutions, as the magnitude of the problems were difficult to discern,” Rosengren said.

While noting differences between problems faced by New England and Japan in the early ‘90s, Rosengren said there are “lessons to be drawn,” particularly that “transparency” is critical to recovery.

Rosengren said he’s hopeful that the current mortgage crisis can be cleared up.

Many economists say the markets are already in the process of sorting out the mess. Chief executives at major firms have been fired. Lenders have gone bankrupt. Financial firms are taking write-offs.

Just last week, Bank of America swooped in and purchased Countrywide Financial Corp., one of the nation’s largest mortgage lenders, for $4 billion, signaling to some it still has faith in the nation’s mortgage and housing market.

But there’s still a lot of uncertainty out there, as shown by the surprise Merrill Lynch report last week.

“We’re not out the woods yet,” said Behravesh.

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