Bad News, but HFC probably deserves it.

I think the weakening in the stock market this past week was largely a result of the following announcement. (There was also some bad news about "flash" technology that hurt the chip manufacturers.)

HSBC Reports Rise in Troubled Loans

('http://www.nytimes.com/2007/02/08/business/worldbusiness/08bank.html');

HSBC Holdings said its charge for bad debts would be more than $10.5 billion for 2006 because of problems in its mortgage portfolio.By REUTERSPublished: February 8, 2007

LONDON, Feb. 7 (Reuters) — HSBC Holdings, a bank based in Britain, said on Wednesday that its charge for bad debts would be more than $10.5 billion for 2006, some 20 percent above analysts’ average forecasts, because of problems in its mortgage portfolio.HSBC said in a trading update late on Wednesday that slowing growth in house prices was being reflected in accelerated delinquency trends across the subprime mortgage market, particularly in more recent loans.Analysts had expected HSBC’s 2006 loan impairment charge to be $8.8 billion, according to the average of 11 analysts’ forecasts, the bank said.That figure is now expected to be about $1.8 billion higher, or about $10.6 billion.


In a nutshell, mortgage defaults are rising.

As I commented before, this is bad news for the housing industry, because fire sale prices on foreclosed homes undercut the market for other sellers. It's bad news for the banking industry, too.

The banks have been trying to get away from default risk on their loans by selling them to other investors. The banks now write the loans, collect the fees, bundle 50 $200,0000 loans together and sell the bundle to some pension fund for a million dollars. I suppose the buyers of the bundle insist on some buy back provisions if the borrower defaults within a the first two or three years. So the banks aren't entirely off the hook. And a lot of these mortgages that are being defaulted on are loans written in 2005 and 2006 when home prices were high and lending practices were relaxed.

HSBC (Hong Kong Shanghai Banking Company) decided to get into the American mortgage market by buying Household International, a lender with the worst of reputations, so their problems are popping up first but this is just the beginning of the mortgage default trend that's got a long way to go.

The folks who hold these bundled mortgages think of them as secured loans and may not appreciate the risk level. Also credit insurance is available and has been fairly cheap for these big investors, but the problem isn't always in getting insurance. Often it's collecting on the insurance. A lot of the insurance they have is written in the derivative market by hedge funds. The insurers were betting nothing bad would happen, and nobody knows if they have the money to pay off if they lose the bet. The harder I look at these insurance policies (credit risk swaps) the more confused I get. This is the old "counter party risk", and it's very hard to quantify- which means its probably worse than you think.. (See Enron)