Foreign love for U.S. assets at risk in subprime drop

By Jennifer Ablan - Analysis

NEW YORK (Reuters) - The deepest housing decline in 16 years could slow an inflow of global capital that has more than funded the massive fiscal and external deficits in the United States.

For years overseas investors have been buyers of American corporate debt, mortgage-backed securities and agency bonds at record pace, helping cover the U.S. current-account deficit -- the broadest measure of international transactions.

But the rapid unraveling of the U.S. subprime mortgage industry, which is stirring new concerns about the already weak housing market, could change all of that.

"The mounting losses in U.S. subprime mortgages and the rising home (loan) delinquencies would likely find foreigners losing their taste for dollar assets in general," said Stephanie Pomboy, an economist and financial analyst at MacroMavens in New York.

A change in foreign tastes would be disruptive since the insatiable hunt for yield has led foreigners to U.S. collateralized debt obligations. These pools of debt assets such as subprime mortgages have boomed amid the global liquidity glut.

And as Greg Peters, head of U.S. credit research at Morgan Stanley, puts it, foreigners have become "big" purchasers of these products in recent years.

In fact, banks doubled the amount of CDOs outstanding in the past two years to $2.6 trillion, including a record $769 billion sold last year, according to JPMorgan Chase & Co. These figures include funded and unfunded issuance.

"Securitized consumer debt like ABS and MBS have been the Gatorade quenching the global thirst for yield," added Pomboy, referring to asset-backed and mortgage-backed securities.

Figuring how much juice foreigners put to work in these CDOs and collateralized loan obligations or other exotic derivatives is difficult to pin down, said Peters and Pomboy.

U.S. Treasury data show in 2006 that 81 percent of net foreign inflows were in so-called agency debt sold by Fannie Mae (FNM.N) and Freddie Mac (FRE.N) and U.S. corporate bonds, which include ABS and MBS. These are securities that are packaged in CDOs.

CAPITAL INFLOWS COULD SLOW

Those staggering inflows into the credit markets could slow, however.

Lehman Brothers estimate that the total market for subprime-related CDOs has lost about $18 billion to $23 billion of its value owing to the recent widening in subprime subordinates and ABS CDOs.

"We think investors and speculators are getting out of existing positions to preserve capital until the dust settles," Marc Chandler, global head of currency at Brown Brothers Harriman, wrote in a report.

"While we aren't suggesting we're clearly at the end of this move, we do think the corrections, while large for a few weeks, are relatively small given the magnitude of the (big price) moves over the past year or so."