Markets tumble amid worries on U.S. growth
By Floyd Norris and Vikas Bajaj
Copyright by The International Herald Tribune
Published: July 26, 2007
NEW YORK: Stock prices tumbled across much of the world Thursday amid worries of slowing economic growth in the United States and more difficult borrowing conditions that could make everything from leveraged corporate buyouts to purchases of new homes more difficult.
In the United States, major indexes including the Dow Jones industrial average and the Standard & Poor's 500 were down more than 2 percent. Losses were comparable throughout Europe, and larger in many developing countries.
"The preconditions for a shock are in place," said Mark Zandi, chief economist at Moody's Economy.com. "Until very recently investors were very nonchalant about risks."
Stock markets have been volatile in recent weeks, as continued strong profits for many companies and an economic boom in Asia have contrasted with signs of slowing in the American economy and new difficulties in borrowing for many that are highly leveraged or have poor credit.
The plunge came a day after the private equity firm buying Chrysler from Daimler-Chrysler said it would complete the transaction despite an inability to borrow the money in credit markets, as had been planned. Banks will hold on to those loans, as they will for a similar deal involving Alliance Boots, a British pharmacy chain. Daimler Chrysler fell $3.95 to $89.07.
"There is fear, but not a fear of recession," said William Gross, the chief investment officer of Pimco, a money management firm. "The fear is directed toward the question of who will be willing to lend $200 billion to provide takeout financing for previously announced private equity deals."
The credit difficulties began in the United States with investors growing worried about losses on securities that helped to finance sub-prime mortgages for borrowers with substandard credit, but now they have spread to highly leveraged companies as well.
"The really good times are over," said Simon Ballard, a global credit strategist at ABN Asset Management in London. "What we have now is a very weak market in terms of credit globally. It will change the environment for higher leverage-type transactions going forward, especially leveraged buyouts."
The credit tightening has come just weeks after Blackstone Group, one of the largest private equity firms that do leveraged buyouts, went public in a widely anticipated initial public offering. The shares, sold for $31, rose as high as $38 on the first day of trading. They rose 19 cents to $25.70 in late trading.
Even as the stock market has gyrated in recent weeks - with the Dow industrials having alternated rising and falling days over the past eight trading days - financial stocks have been coming under pressure. Citigroup dropped $1.40 to $47.81, and Goldman Sachs fell $8.04 to $195.12.
The falling stock markets helped turn oil markets lower. After rising above $77 a barrel in early trading - the first time since last summer that level was hit - the nearby crude oil future fell back below $75.
Exxon Mobil reported its first earnings decline in years, saying it made $10.3 billion in the second quarter, about $100 million less than in the same period of 2006. Earnings per share were up, due to an aggressive share-repurchase plan, but Exxon stock fell $4.56 to $88.23.
American investors were also depressed by a report of slowing sales of new homes, and by reports of losses from homebuilders. Beazer fell $1.48 to $15.56, and has now lost two-thirds of its value this year.
Beazer faces a criminal investigation for arranging government-guaranteed mortgages for buyers who should not have qualified, but other homebuilders have also plunged. Pulte Homes fell 63 cents to $20.04 and Ryland Group rose 35 cents to $33.27. They are off about 40 percent this year.
Not all stocks were lower. Apple, which lost 8 percent of its value on Tuesday amid fears that its iPhone had not sold as well as expected, has regained all of that loss as it reported strong profits. MMM, which reported record profits, was the only one of the 30 Dow industrials to be up in late trading.
The yield on 10-year U.S. Treasury bonds fell to 4.79 percent from 4.90 percent the day before, as some investors sought safety, but yields rose as prices fell for bonds of lower quality, and some were difficult to sell at all.
"We needed to clean house and it's getting cleaned," said Kingman Penniman, the president of KDP Investment Advisors, which focuses on high-yield bonds. "It's the market going from too much liquidity to none. Many of the participants have never seen it."
Standard & Poor's, in its leveraged commentary report, said the decline in high-yield bond prices this week was the largest since the plunge after the Sept. 11 terrorist attacks.
"It's pretty clear that this is a big move away from taking risk," said Jerry Webman, senior investment officer and chief economist for OppenheimerFunds, a mutual fund company. "People have been borrowing unusually cheaply to buy assets, and that whole transaction made sense whether it was houses or companies - if the asset was going to appreciate. But if that asset was not going to appreciate, your loan was not going to work."
The fall in Treasury bond rates has also done little for mortgage rates, Freddie Max reported that the average rate for 30-year mortgage loans was 6.69 percent. Since mid-June, Treasury rates have fallen by half a percentage point, but only a tenth of that move has carried over to the mortgage market.
In the past, a sudden seize up of lending has sometimes led to sharp market falls. A leveraged buyout boom in the 1980's came to a halt when a planned buyout of UAL, the parent of United Airlines, could not be financed. The S&P 500 fell 6 percent in one day when that was announced, but regained all the lost ground within 12 weeks.
In those days, a financial crisis raised fears of failures for large financial firms.
Now, policy makers like Ben Bernanke, the chairman of the Federal Reserve, have argued, markets can deal with shocks better today than in the past because risks are more dispersed.
Securities backed by risky mortgages that have been a top concern, for instance, are held by pension funds, hedge funds and many other investors around the world. So, they argue, even if the market for those bonds collapses, no major firm is likely to be seriously injured.
But the big banks now find themselves taking on more loans because they had promised to do so if the loans could not be sold. And the market for some types of securities has all but vanished.
Countrywide Financial, the nation's largest mortgage lender, said this week it would no longer try to sell the riskier mortgage securities that it used to routinely unload. Countrywide fell 82 cents to $29.25, a three-year low.
"Everybody now recognizes that the elimination of creative finance in housing leaves us with a problem for new homebuyers," said Robert Barbera, the chief economist of ITG, because their income is not high enough to buy homes with interest rates and home prices at current levels.
"You can make the case that we are simply witnessing a reverse of the late 1990's - Asia collapse, long-term interest rates swoon and U.S. housing booms."
This time, he said, interest rates may not fall much, due to the Asian boom, and that will put more pressure on housing prices.