More Shoes to Fall

It looks like investors woke up this morning and puked when they read the front-page stories about big banks pooling together to create liquidity backup for subprime mortgage paper and other loans.

The major stock indexes are off a percent. But the biggest losers were the financials which were down almost 2 percent. Among that group, the hardest hit were Citi, Lehman, Merrill, Bear, Goldman, Washington Mutual, Freddie Mac, and Countrywide.

The ABX BBB minus index of subprime paper fell four dollars from $29 bucks to $25 bucks. Incidentally, that index stood at a hundred on January 1st.

Now let me get this right. Here’s my reading. At the urging of the Treasury, the big banks that couldn’t sell asset-backed commercial paper, have decided to pool their resources and create a new vehicle to do what? Sell more asset-backed commercial paper. The markets aren’t buying it. They gave it a big Bronx cheer.

There’s something like $500 billion dollars worth of asset-backed commercial paper to be rolled over in the next few months. And, while no one can be sure, there’s something like $500 billion dollars worth of subprime securitized mortgage bonds, plus leveraged loans from various buyouts and the private equity deals that are sitting on bank shelves.

Eventually this paper will be sold at big discounts. Now the banks will take big haircuts, cutting into their loan loss provisions, and their capital adequacy ratios. That, in turn, may reduce the availability of loans to money good businesses and consumers.

In other words, the subprime credit crunch has additional shoes to fall. While it’s quite true that jobs and incomes look pretty good, it is also true that credit turmoil is not yet over.

Goldilocks is looking at all this with great caution.