US Mortgage Crisis Hits Pacific Rim Markets

FRANKFURT: Fresh signs of trouble for U.S. mortgage lenders and ripple effects even across the Pacific unleashed a massive sell-off in Asian markets Wednesday. But the losses were more modest in Europe and on Wall Street as the U.S. Treasury Secretary cautioned against panic.

The tumbling markets around the Pacific Rim underscored how quickly something that was regarded as a smart financial innovation a year ago can turn into a source of global instability.

Lenders in the United States sold their subprime mortgages - loans made to less creditworthy buyers - on to investment banks, who repackaged them as bonds and peddled them worldwide. Now that the U.S. housing bubble is bursting, defaults on the underlying mortgages are rising and the impact is being felt around the globe, even though economic growth elsewhere is solid.

A warning Tuesday from one subprime lender, American Home Mortgage Investment, that it could face liquidation preceded the Asian rout. Then Bear Stearns, which saw two of its hedge funds collapse last month, said it had barred investors from pulling money out of a third fund while it evaluates how to best emerge from the crisis.

Fanning the flames was an announcement by Standard & Poor's that it was considering lowering its credit rating on several funds dealing in affected securities.

On Wednesday, Macquarie Bank, an Australian financial services giant, announced that investors in two of its funds might lose 25 percent of their money. The funds, worth $873 million, actually held no subprime securities, but other holdings fell in value in the wake of that debacle, forcing Macquarie to liquidate assets - the first sign that the crisis was spreading to other sectors of the credit market.

With the crisis having originated in the United States, investors are now looking to the world's largest economy for signs that "things are not that bad," said Tim Condon, head of research at ING Financial Markets in Singapore.

"The markets don't care that the rest of the world is booming," he said.

U.S. Treasury Secretary Henry Paulson Jr., traveling in China, sought to calm nerves by portraying the losses as something of a correction, after years in which investors forewent the premium they normally demand for shakier investments.

"We have the strongest global economy I've seen in my business lifetime today," Paulson told reporters in Beijing, The Associated Press reported. "What is going on in my judgment is a reassessment of risk."

Earlier, stock markets around the Pacific Rim had plunged, with Japan's Nikkei stock average falling over 2 percent, erasing its gains so far this year. Hong Kong and Australia's benchmark indexes both fell by more than 3 percent. But one of the most dramatic declines was in Seoul, where South Korea's key index slumped 4 percent.

Macquarie's stock skidded 11 percent, its biggest one-day drop in over five years, even though the bank stressed that the investments remaining in the funds would probably recover.

"There have been no defaults in the portfolio and no reason to believe that the loans in the portfolio will not continue to pay their periodic interest and repay the principal outstanding at par," it said in a statement.

Later in Europe, major indexes in Germany, Britain and France all closed lower as well, but all less than 2 percent down. In the United States, stocks finished higher.

Other information that emerged on Wednesday pointed to a limited impact of the subprime crisis.

A small German bank, IKB Deutsche Industriebank, had to be rescued Monday by its main shareholder, a government-owned bank, to the tune of €8.1 billion. But Torsten Albig, a spokesman for the German finance ministry, denied that the intervention was meant to nip a broader crisis in the bud.

"There would have been a localized impact on IKB and it was necessary to avoid that," Albig said when asked the reason for the bailout.

Axel Weber, president of the Bundesbank, said Wednesday that German banks' investment in the U.S. housing market was limited and they could cope with possible losses as a result of subprime mortgage defaults, Bloomberg News reported.

MetLife, the largest U.S. life insurer, said Wednesday that it had about $2.3 billion in securities linked to subprime residential mortgages at the end of the second quarter. But that was less than 1 percent of the company's invested assets, Bloomberg reported.

Because no one has a definitive overview of who bought subprime-based securities, investors have been left to ponder where the next hit may come.

Mainly for defensive reasons, they have bid up the cost of insurance on corporate debt - known as credit default swaps - paving the way for funds that have no exposure to the subprime sector, like Macquarie's, to suffer big losses.

The turbulence in Asia may also deal a blow to the thesis that Asia has effectively "decoupled" from the American economy through greater intra-regional trade. But financial markets have now transmitted unexpected U.S. shocks to Asia.

"This myth has been perpetuated that Asia has been decoupled, which is a truckload of baloney in my view," said Venkatraman Anantha-Nageswaran, head of research at Bank Julius Baer in Singapore.