Bond insurer rescue plan gives hope, problems remain

LONDON, Jan 24 (Reuters) - A leveraged loan logjam on bank balance sheets, Europe’s frozen securitisation market and rising consumer credit risks must be tackled if a plan to bail out ailing U.S. bond insurers is to help end the global credit crunch.

News of the potential insurer rescue boosted the belief that regulators and politicians are acting to stave off the impact of the credit crisis that erupted last summer, putting a floor under plunging sentiment on stock and credit markets.

But more action from policymakers and regulators will be needed for real confidence to return as fundamental problems still threaten the smooth functioning of global financial markets and, a consequence, the world economy.

“I don’t think the rest of the market’s going to open up quickly. It’s going to take time,” said Vivek Tawadey, head of credit strategy at BNP Paribas.

“Fundamentally you’ve still got a severe deterioration in the housing market, which appears to be extending to other asset classes like credit cards, auto loans and the like, that is playing out irrespective.”

Analysts are anxiously awaiting details on the plan by New York regulators to save bond insurers’ crucial triple-A ratings and stave off forced sales of billions of dollars of bonds that the insurers have guaranteed. [ID:nL24651124]

“There are many behind the scenes meetings going on at the moment,” credit strategists at Deutsche Bank led by Jim Reid said in a note to clients.

“Central banks, regulators and governments are not oblivious to what’s going on, and we reiterate the belief that although we feel like being much more bearish we are definitely holding back because of the expectations that we will get headlines like those from the NY regulators,” they wrote.

Investors are particularly looking for information on how banks would be persuaded to commit capital to the insurers when they have already been battered by the subprime crisis.


“The choice is between the devil and the deep sea. You have prospects, if the monolines get downgraded, of large mark-to-market losses. On the other hand to prevent that from happening you may have to inject some capital to preserve their ratings,” Tawadey said.

Deutsche Bank’s strategists too cautioned that there is a risk that while the financial sector may start to recover from the crisis, the problem shifts to the non-financial sector in that banks remain unwilling to extend credit.

Equity prices rose sharply on Thursday, with the FTSEurofirst 300 .FTEU3 up 4.95 percent by 1340 GMT, while the Markit iTraxx Europe index of investment-grade credits ITRAC5EA=GFI tightened around 5 basis points to 74.75 bps.

Other markets remain stuck.

A backlog of about $118 billion of unsold bank loans lies obstinately untouched in Europe, with investors in no hurry to buy debt with thin covenants from highly leveraged companies.

The asset-backed market too -- a key source of consumer credit -- is still a pale shadow of its former self, threatening mortgage lending.

“(The) securitisation cash machine has broken down,” said Myles Bradshaw, a vice president at bond fund giant PIMCO.

Bradshaw added that while central banks had acted to boost liquidity in the inter-bank market, there was no guarantee this benefit would be passed on as investors remain unwilling to put cash to work in financing mortgages.

Investors in the structured credit market are defensive and confidence is shaky, said a European banker who structures synthetic collateralised obligations (CDOs), but there are measures that could be taken -- again by regulators.

“To resolve this crisis, accountants and regulators would be much more powerful than central banks,” said the banker, who declined to be identified.

For example, European accounting rules require investors to mark to market any change in price of their holdings of derivatives, even when they plan to hold them to maturity and the prospects of any default loss in the end are miniscule.

This has led to a vicious cycle as some investors bound by mark-to-market rules have been forced to sell holdings, driving down prices to fire-sale levels and forcing further disposals.

Regulators could boost confidence by lifting the mark-to-market rule for buy-and-hold investors, the banker said. Otherwise it becomes a matter of time for the market to recover.

Additional reporting by Jane Baird in London