Wall Street and our market have returned to ignoring the elephant in the room.

This week has seen some confidence return in markets, thanks to falling oil prices and a turnaround in the value of the US dollar which is helping drive the sell-off in commodities.

But any thought of a cheering rally should be put to one side as we had more examples of the damage still being done from the US housing and subprime mess, with the Freddie Mac mortgage insurer in the US raising worries once again about its viability. And there seems to be worse to come.

The world’s biggest insurer, American International Insurance Group (AIG), and Freddie Mac revealed write-downs and losses on housing-related securities and other bits of paper of more than $US15 billion. AIG had losses of more than $US12 billion, Freddie Mac over $US3.5 billion.

AIG reported a $US 5.4 billion second-quarter loss, but more worrying was the news that underlying earnings (excluding the write-down losses) fell into the red by far more than analysts had speculated: $1.32 billion as rates fell and the credit crunch hit returns on the insurers own funds (something we have seen here with Suncorp and IAG).

Overall AIG’s loss represented a near $US10 billion turnaround from the $US4.28 billion second quarter profit last year.

AIG cut the value of credit-default swaps, guarantees AIG sold to protect-fixed income investors, by $US5.56 billion and marked down other holdings by $US6.08 billion before taxes: those are losses in the same ballpark as those some quarters from Merrill Lynch, Citigroup, Lehman bros and UBS.

But it was Freddie Mac, the smaller of the two quasi-US Government sponsored companies (Fannie Mae is the other) which stunned US markets with a loss much larger than anyone had thought. It lost $US821 billion in the second quarter, and the shares again fell. The company now has a market capitalisation of $US4.6 billion at the end of trading this morning. That’s supporting over $US1 trillion in mortgages.

The group slashed its dividend to just 5 US cents a share and will save $US500 a year (why didn’t it just cut it completely?), it said it could raise $US5.5 billion in fresh capital, right now, but the market conditions were not welcoming. But seeing that existing shareholders would suffer a 100%-plus dilution

But the real message from Freddie Mac’s result was buried in the detail. For the first time it has started writing down the value of home mortgages in its so-called Alt-A class: they are better quality than subprime, but are not prime mortgages. It wrote those down by $US1 billion and provided a further $US2.5 billion for more credit losses in other parts of its mortgage portfolio. Freddie’s did this because it sees a deteriorating outlook for house prices and delinquencies and it is preparing itself for even worse news on falling home prices.

The CEO, Richard Syron, said in a briefing that America’s housing crisis was only at its half-way point, with prices expected to decline nationally by up to 20% before the market stabilises. Freddie estimates that US house prices have fallen by about 9%, while the broader Case/Schiller index says they are down 15.8% over the past year to June.

Peter Fray

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