Subprime Market Risk Going Up

Markets are clearly trading on apprehension, as there remain concerns relating to the U.S. subprime mortgage market along with the state of the U.S. credit market and its potential negative impact on the economy. On Friday, the Federal Reserve cut the discount rate by 50 basis points to 5.75% from 6.25%. In addition, the Fed injected another $3.5 billion into the U.S. banking system to try to support the credit markets against a potential downturn. The Fed provided about $120 billion in cash to the banking system last week. In my view, the concerns are serious.

 The central bank has suggested that the risk from the subprime market has increased. The problems with the subprime market are expected to slow GDP growth to 2.5% in the second half, according to the Fed. “Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing,” said the Fed. At this point, analysts believe the Fed will keep interest rates intact for the remainder of this year.

 Rating agency Standard & Poor’s said that it might need to reduce the credit rating of over $12.0 billion in bonds that are backed by subprime loans. Standard & Poor’s said that U.S. home prices have fallen for five straight months.

 In sector news, the subprime concerns are already impacting companies. Two hedge funds managed by The Bear Stern Companies, Inc. (NYSE/BSC) that focused on the mortgage market collapsed. American Home Mortgage Investment Corp. (formerly NYSE/AHM; now Pink Sheets/HMIQ) is facing some problems with its credit lines.

 Mortgage lender Countrywide Financial Corporation (NYSE/CFC), the country’s largest mortgage lender, reported a three-percent decline in second quarter earnings and made a downward revision in its fiscal earnings outlook. On Monday, Countrywide Financial announced that it would be issuing pink slips in order to deal with the credit crunch. The news came after the company had to borrow $11.5 billion to make home loans.

 The erratic market swings in recent weeks reflect the uneasiness in the markets. As an investor and trader, you need to be careful in this market and protect your capital. Taking big risks could take a chunk out of your capital and leave you sitting on the sidelines. Be careful and you will live to trade another day.