Aug 17, 2007 Asia Times

SEOUL - "Blood is hitting the streets. Everyone seems to be panicking, and there's reason to panic," Bloomberg quoted Patrick Chang of CIMB-Principal Asset Management Bhd in Kuala Lumpur as saying. "There's been so much blow-up, we don't know when it's going to end. Liquidity is drying up."

The repercussions in Asian markets were bigger in comparison to the loss of 1.29% overnight on the Dow Jones Industrial Average in the United States.

South Korea's stocks plunged 6.93%, with the benchmark Korea Composite Stock Price Index (KOSPI) plummeting 125.91 points to 1,691.98. "The subprime-mortgage defaults caused larger-than-expected ripple effects," said Lee Yoon-hak, an analyst at Woori Investment and Securities.

The South Korean currency closed at 946.2 won to the greenback, plunging 13.7 won from the previous close as offshore investors scrambled to purchase US dollars after dumping shares in the local market.

Experts fear that the rising defaults in US subprime mortgages could result in an economic slowdown in the United States and a global credit crunch, and nervous investors have picked up on the anxiety, whether it's justified or not.

"South Korea's stock market is overly sensitive to the subprime-mortgage financial crisis," a presidential spokesman said. "The fundamentals of the South Korean economy are solid ... but we will quickly inject liquidity into markets if it looks as if a credit crunch will materialize here."

South Korean banks and insurers invested a combined US$850 million in US subprime-mortgage-related bonds as of the end of July, with their combined losses coming to $85 million, according to government data.

In Tokyo, stocks fell 1.99% to an eight-month low on Thursday. The Nikkei-225 index of the Tokyo Stock Exchange shed 327.12 points to end at 16,148.49. And this was after the Bank of Japan (BOJ) had injected 400 billion yen ($3.4 billion) into the money markets in the morning. The US dollar was trading at 115.88-115.90 yen late on Thursday, down 1.05 yen.

Who carries the losses?
The complex nature in which subprime loans are securitized and sold obscures who will shoulder the bulk of the losses.

The cascading fallout from rising defaults on home loans in the US extended to borrowers with poor credit has weighed on Japanese stocks in part on concern that foreign hedge funds will sell their Japanese shares for cash.

Export-oriented firms sensitive to consumer spending trends in the US have been hit hardest. On Thursday, Toyota Motor Corp dropped 2.9%, Honda Motor Co dipped 2.7% and Sony Corp declined 2.6%.

Individual investors in Japan snatched up shares when stock prices plummeted at the end of February, but they are waiting on the sidelines this time. In addition, a stronger yen has hurt individuals who moved money from stocks to foreign-exchange margin trading.

US Federal Reserve Board chairman Ben Bernanke said in congressional testimony last month that financial institutions may shoulder $50 billion to $100 billion in losses due to defaults on subprime mortgages.

In the case of the savings-and-loan crisis in the US in the latter half of the 1980s, costs associated with Resolution Trust Corp's takeover of financial institutions and bad loans reached 2% of nominal gross domestic product (GDP).

Should the losses related to subprime loans be at a level predicted by the Fed chairman, they would amount to less than 1% of US GDP, leading many market players to believe that the impact on US financial institutions will be limited.

The effect on Japan's financial institutions is even smaller. Losses related to the subprime-loan problem disclosed by the three major banking groups - Mitsubishi UFJ Financial Group Inc, Mizuho Financial Group Inc and Sumitomo Mitsui Financial Group Inc - come to just several hundred million to several billion yen.

Despite these figures, instability in the stock market continues partly due to unease that new losses will come to light. Some 80% of the balance of subprime loans have been securitized, such as into residential mortgage-backed securities. Because these have been repackaged and sold to various investors, it is difficult to see who will suffer losses, and this is making stock prices fluctuate wildly.

To deal with the spreading subprime-loan jitters, central banks in Japan, the US and Europe have pumped large amounts of funds into money markets since the latter half of last week in an attempt to prevent a crisis in which financial institutions lack the necessary funds for settlements.

The moves were seen not just as an attempt to alleviate credit concerns and prevent a sharp rise in market interest rates but as a clear indication from the banks that they will do everything in their power to prevent a panic.

The central banks will recover the funds they injected when market instability recedes or when open-market operations expire. The BOJ absorbed surplus funds for two straight days on Tuesday and Wednesday when the Japanese market settled down, but was forced into action again on Thursday.

(Nikkei/Asia Pulse)