WALL STREET – Credit union executives were watching to determine the impact of the spreading financial crisis precipitated by yesterday’s bankruptcy of Lehman Brothers Holdings, and to a lesser extent the takeover of Merrill Lynch by Bank of America and the troubles at insurance giant AIG – all major players in the mortgage market.
Markets gyrated throughout the day, with the Dow Jones Industrial Average plunging more than 500 points. Spreads again widened on mortgage backed securities as the expanding crisis threatened to unravel the multi-trillion dollar market for credit insurance, known as credit default swaps, a little known market that reaches through major corporations in the U.S. and overseas.
“The problem is, what is the exposure to counter-parties around the world of Lehman not being able to meet their obligations,” said Dwight Johnston, a senior vice president at WesCorp FCU. “That’s what’s driving all the fear and loathing in the market.”
“The biggest issue is credit default swaps,” Johnston told The Credit Union Journal. “It has the potential to drag down AIG and others.”
Credit default swap spreads were widening on Washington Mutual, Wachovia and other major financial institutions yesterday, indicating investor fears of those companies.
The fears so stoked the credit markets that the rate on overnight Fed Funds, an important provider of short-term liquidity in the credit union industry, surged to 3.5% at the market’s opening yesterday, and as high as 6%, even as the Fed’s target rate remained at 2%. The Fed is expected to cut that rate even more today as it moves to shore up confidence in the financial markets.
Among the questions being explored yesterday were: what impact the Lehman failure will have on the secondary mortgage market, just as last week’s federal takeover of Fannie Mae and Freddie Mac appeared to calm the secondary market.
“The number of players could be declining here in the secondary market,” said Brian Turner director of Southwest Corporate Investment Services, a unit of Southwest Corporate FCU. “With fewer players, how will it affect spreads?”
Another question: what effect will the Lehman failure have on the valuation of mortgage backed securities, especially so-called private label issues sold by Lehman and other Wall Street banks?
Natural person credit unions hold few private label issues, but corporates hold billions of dollars worth, and those securities were being hammered in the market, even if they were protected from default by being sequestered in independent trusts.
Also, what effect the spreading credit crisis will have on rates, both for loans and deposits? Representatives throughout the credit union industry have reported that banks needing liquidity have been pushing up deposit rates to attract new funds, requiring credit unions to respond in kind to retain deposits – pushing up their cost of funds. The situation has slowed credit union deposit growth this season, a traditional time for strong influxes of deposits.
