Stock Market Contagion Fallout Ahead

COLLEGE STATION, Tex. – In the wake of last week’s tumbling stock market activity, Treasury Secretary Henry Paulson insisted that subprime mortgage market difficulties are "largely contained," but at least one noted economist says the evidence suggests otherwise.

“Harvard's endowment association just lost $350 million in a matter of days,” said Dr. Mark Dotzour, chief economist with the Real Estate Center at Texas A&M University. “And now a major bank in Australia is showing strain from the mortgage market as well.”

Dotzour says stories like these are shaking the foundation of the bond market, and the aftershocks are being felt in the stock market.

“What was once thought to be an isolated problem in subprime loans is fast becoming a problem in Alt A (near prime) mortgages and prime piggyback mortgages, and it more ominously has migrated into the corporate bond market,” he said.

Dotzour says the recent activity has resulted in a term new to the bond markets — contagion — and he predicts that the fallout is on the way.

“Over the coming weeks, I think we could see more hedge funds going bankrupt, major banks taking large losses on mortgage loans, credit spreads widening, and leveraged buyouts of companies being delayed because the banks can't sell the loans,” he said.

Some lenders and hedge funds have a lot of pipeline risk right now. According to Dotzour, they have a total of about $200 billion in loans that have not sold yet.

“Somebody has lost a bunch of money, but as of now we don't know who,” he said. “My guess is that the bad news in the capital markets will leak out gradually over the next few weeks. It won’t be pleasant to follow.”

The Real Estate Center (recenter.tamu.edu) has been providing solutions through research for 35 years. Funded primarily by Texas real estate licensee fees, the Center was created by the state legislature to meet the needs of many audiences, including the real estate industry, instructors, researchers and the general public.

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