By John Parry
NEW YORK (Reuters) - Credit market strains may start to abate in early 2008 once banks get through the next round of revealing losses from riskier assets, fund managers at the Reuters Investment Outlook 2008 Summit said this week.
Central banks' plan, unveiled on Wednesday, to add temporary reserves may also help to cushion the global banking system from shocks of more losses from the melt down in U.S. subprime mortgages. But for elevated short-term borrowing costs to come down substantially, market participants need a more up-to-date tally of how much red ink the banking system has bled, fund managers said.
Until then, the specter of uncertainty about banks' unknown losses in credit markets will likely haunt banks and clam up lending. Banks' financial results issued in early 2008 may be ugly, but investors will be relieved to know the worst.
Tom Sowanick, chief investment officer with Clearbrook Financial LLC in Princeton, New Jersey, said concerns about the structured credit that banks and brokerage firms own, "will come to a rest by the end of the first quarter or the end of the second quarter at the latest because (by then) many financial firms report and they won't hide that from their auditors."
For now, banks are hoarding cash to cushion themselves against the risk of more write downs and against so called "counterparty risk" in interbank lending markets: the danger that a borrower might not be able to repay a short-term loan. These trends have kept short term lending rates atypically high since credit market turmoil erupted in August.
Libor, or the London interbank offered rate, is some 75 basis points above the federal funds target rate, the key U.S. overnight lending rate. That's way above its historical long term average of within about 12.5 basis points, analysts note.
Libor, the main short term borrowing rate in Europe and for adjustable-rate mortgages in the United States, is likely to remain high into the first quarter, said Deborah Cunningham, who manages Federated Investors U.S. and euro money market funds totaling $210 billion in assets.
In Europe, "banks are not trustworthy of each other" in short term lending markets, said Cunningham, who chief investment officer for taxable money markets at Federated Investors Inc.
"Until there is a lot of year end of reporting, that rate (the spread of Libor over the U.S. fed funds target rate) will stay wide," Cunningham said.
Most European banks are expected to report their next round of financial results between mid-February and early March.
By mid-2008, when most banks' write-offs from subprime mortgage debt related losses will have been undertaken, the Libor-fed funds target rate spread should shrink, said Margaret Patel, managing director and senior portfolio manager with Evergreen Investment Management Company, LLC in Boston.
She added that banks have adequate capital ratios to absorb such losses.
Yet many uncertainties remain after a frighteningly swift erosion of investor confidence.
The upheaval in short term money markets including the U.S. asset-backed commercial paper market, which has shrunk by one third since August, was one of the biggest upsets to investors in 2007. Some see potential for the tumult to last much further into 2008 and perhaps beyond.
And some fund managers warn that the banking system may face a much bigger problem than most analysts realize. That's because the slicing and dicing of U.S. mortgage-backed assets that turned bad has spread so widely throughout the world as banks took stakes in collateralized debt obligations and structured investment vehicles. The extent of exposures via these vehicles is very hard to pin down. Continued...
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