Thursday, January 31, 2008

Subprime Pain Continues to Haunt Wall Street Banks

The Wall Street Journal reported today that UBS AG had accumulated more than $100 billion in mortgage related losses over recent months and would write down an additional $4 billion in capital.

Those concerns were in the spotlight yesterday as Oppenheimer & Co analyst Meredith Whitney warned that Wall Street faces at least $40 billion in losses if the insurers see their credit ratings cut or file for bankruptcy protection. On top of this, Standard & Poor's predicted yesterday that the carnage might spread to a wider range of financial institutions, with total losses potentially exceeding $265 billion.

Citigroup and Merrill Lynch were the leading issuers of complex investment vehicles called collateralized debt obligations, whose values have deteriorated as more borrowers defaulted on mortgages. Together, Citigroup and Merrill already have absorbed a total of nearly $45 billion in losses on exposure to CDOs, leading each to replace its chief executive and seek multibillion-dollar cash infusions from investors around the world.

But the banks are hardly immune to further erosion. They each have billions of dollars in remaining exposure to CDOs, pools of debt sliced up according to levels of risk. Their values are expected to continue dropping, and yesterday S&P took negative action on nearly 2,000 CDOs backed by mortgages.

Still, with interest rates falling, the share prices of some financial institutions had gained nearly 20% recently. "A lot of investors want to believe [the fourth-quarter losses] were the end," said Joseph Mason, a finance professor at Drexel University's business school. "We're definitely not done here."

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