- The Washington Times - Thursday, September 6, 2007

Evidence of a sudden collapse of pending home sales and new jobs at the onset of an acute credit crunch reignited worries in financial markets yesterday, even as top finance officials warned that the turmoil will continue for months.

A report from the National Association of Realtors showed a record 12.2 percent drop in pending home sales in July as jumbo home loans of more than $417,000 suddenly became hard to get, while the nation’s largest temporary-employment agency, ADP Employer Services, reported the slowest growth in jobs in four years during August — both signs that the acute problems in financial markets quickly spread to the broader economy.

While a separate Federal Reserve staff report yesterday found only a “limited” impact in most areas from the credit crunch, the news sent the Dow Jones Industrial Average down 143 points and spawned a flight into safe-haven Treasury bonds as investors fretted about the future of the U.S. economy.

The revival of economic worries came one day after automakers blamed the credit crunch for weak sales during August and as Moody’s Investors Service and a top Treasury official said it will take months for the crisis to play out in financial markets and the economy.

“This process is far from over,” said Treasury Undersecretary Robert K. Steel, testifying before the House Financial Services Committee that markets will continue to be roiled as investors reassess the risks posed by rising defaults and shut off funds for easy-money loans like the ones that are now ending in foreclosure.

“Certain segments of the capital markets are stressed,” Mr. Steel said. “The ultimate impact of these events on the economy has yet to play out,” but the episode fortunately occurred at a time when economic growth here and abroad was healthy, he said.

While Mr. Steel said some retrenchment of credit is normal after a period of loose lending such as occurred during the housing boom between 2003 and 2006, the pullback in the past three weeks has been precipitous and ferocious, causing an unprecedented drop in the interest charged on Treasury securities of 2.5 percentage points as investors dived into the safest, most liquid securities and dumped their riskier holdings.

Moody’s said the flight to quality has been so exaggerated that it will take another six months before the major disruptions in the mortgage and corporate debt markets can unwind and normal buying and selling activities can resume.

“Panic is driving a lot of the pricing, and lack of confidence is painting all assets — good and bad — with the same broad brush,” said Moody’s Vice Chairman Christopher Mahoney. The dislocations have been so extreme, he said, that markets will have to develop an entirely new “price consensus” that assigns generally accepted values to subprime and other risky securities currently spurned by the markets at any price, he said.

“For now, there is no standard for what market pricing should be with differences in opinion among buyers and sellers,” he said. “In some cases, even good collateral cannot be sold or financed at anything approaching its true value” because investors have grown so wary of default risks, he said.

The Fed is playing an important role by accepting good quality mortgages as collateral for short-term loans at a time when private investors will not, he said.

While markets eventually will re-establish equilibrium, prices could fall dramatically in the meantime — driving down the value of trillions of dollars of investments held by Wall Street investment houses, insurance companies, pension and mutual funds, as well as hedge funds, which are likely to take the biggest hits because they went heavily into debt to acquire the securities, he said.

“Some levered players will ultimately be forced to sell illiquid securities at low prices,” he said. “This forced selling should result in the creation of a more liquid secondary market” for subprime mortgages and other risky securities.

While some warned of a difficult path to recovery, the Fed’s staff found that the broad U.S. economy initially felt little impact from the credit crunch beyond further depressing the already sinking housing market.

“Recent developments in financial markets had led to tighter lending standards for residential mortgages, which was having a noticeable effect on housing activity,” the staff said in its periodic “beige book” report, an anecdotal assessment of economic conditions to be presented to the Fed’s interest-rate-setting committee this month.

“The weakness in the housing market deepened across most districts, with sales weak or declining and prices reported to be falling or flat. … The reduction in credit availability added to uncertainty about when the housing market might turn around,” the Fed report found.

But “outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited,” the report said.

The report did not assuage worries on Wall Street, however, where many have been hoping that the Fed will slash interest rates this month out of concern that credit problems are infecting the economy — hopes that are undermined by the Fed’s upbeat assessment.

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