Liquidity Fears Rattle Market

Posted on August 9, 2007

The Dow Jones Industrial average dropped almost 2.8% today, its second worst drop this year. The drop is being attributed to the collapse of the subprime mortgage lending market and liquidity problems. Things got so back today that the European Central Bank and the Fed had to intervene and try to ease liquidity problems.

The troubles demonstrated both the global reach of the crisis and its impact on a widening circle of markets and companies. The first jolt came from French bank BNP Paribas, which said early in the day that it was freezing three investment funds once worth a combined $2.17 billion because of losses related to U.S. housing loans. That prompted the U.S. and European central banks to inject cash into money markets to keep interest rates down.
The unease accelerated in the U.S. with news that several hedge funds were in the red and selling off assets. Apartment and condominium builder Tarragon Corp. raised doubts about its ability to remain in business amid weak demand and an inability to raise new financing. After markets closed, mortgage-lender Countrywide Financial Corp. said "unprecedented disruptions" in credit markets could affect its financial condition.
The stock market, which on Wednesday had risen sharply on hopes credit problems were being contained, swooned as hedge funds, many of which borrowed increasing amounts of money in recent years to boost returns amid placid markets, scrambled to sell holdings and cut their borrowings. The Dow Jones Industrial Average ended down 387.18 points, or 2.8%, at 13270.68.
After the close of trading, Renaissance Technologies Corp., a hedge-fund company with one of the best records in recent years, told investors that a key fund has lost 8.7% so far in August and is down 7.4% in 2007. Another big fund company, Highbridge Capital Management, told investors its Highbridge Statistical Opportunities Fund was down 18% as of 8th of the month, and was down 16% for the year. The $1.8 billion publicly traded Highbridge Statistical Market Neutral Fund was down 5.2% for the month as of Wednesday.
Meanwhile, Countrywide, of Calabasas, Calif., said in a Securities and Exchange Commission filing that it was shoring up its finances and had "adequate funding liquidity." (SEC filing3) But the company, the nation's largest home-mortgage lender in terms of volume, warned that "the situation is rapidly evolving and the impact on the company is unknown." Reduced demand from investors is prompting Countrywide to retain more of its loans rather than selling them.
The statement could send shivers through financial markets today. It came just a week after Bear Stearns Cos., the Wall Street trading giant, had to reassure investors that it had ample cash on hand amid concern that it faced funding problems because of deteriorating credit-market conditions and the implosion of two of its hedge funds.

The domino effect of the collapse of the subprime lending market is hardly a surprise to anyone who has been following the irrational exuberance investors have been showing for mortgages that have little or no chance of being repaid. Governments are clearly worried: Japan's central bank added $8.39 billion into money markets, the European Central Bank injected $130 billion and the Federal Reserve had to cough up $24 billion to stop a liquidity panic. It's not over yet and the market jitters are already spreading to non-mortgage-related stocks.