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Financial Sector Funds Struggle under Subprime Meltdown

The U.S. subprime debacle continues to be the focal point of global financial markets. News from financial institutions or hedge funds reporting either significant losses or facing liquidity. ....

The U.S. subprime debacle continues to be the focal point of global financial markets. News from financial institutions or hedge funds reporting either significant losses or facing liquidity difficulty appears to dominate the headlines everyday. The global equity fallout of two weeks ago was a prime example the ripple effect the subprime meltdown had on the world economy. It also served as a clear refute to some of the initial theory that the U.S. credit issue should not spread beyond its borders. Financial stocks, being the epicenter of the whole crisis, were amongst the hardest hit. As of August 27, the MSCI World Financials Index fell 4.33% year to date. American financial companies tumbled badly as well: financials are 7.62% into the red this year, the worst among the ten S&P500 sectors.

Mortgage providers were the first domino to fall under the subprime fiasco. American Home Mortgage and Aegis Mortgage, the tenth- and thirteenth-largest mortgage provider in the U.S., both filed Chapter 11 bankruptcy petition earlier this month. The nation's largest lender, Countrywide, also faced serious liquidity difficulty and has to tap into its bank credit line after being shut out from the commercial paper market. Investment banks and security houses with sizable holdings in subprime-backed securities also suffered significant trading losses or provisions. Bear Stearns, the second largest mortgage backed securities underwriter, saw its share stumbled 33% since turning the calendar.

The U.S. Federal Reserve unexpectedly lowered its discount rate by 50bp to 5.75% on August 17, in an effort to increase liquidity in the credit market. The news was a shot in the arm for anxious equity investors worldwide. In the accompanying statement the Fed acknowledged that “downside risks to growth have increased appreciably” and abandoned mentioning inflation as its chief concern. Traders speculate the Fed to lower its benchmark lending rate as early as its next scheduled meeting in September, sending global equity markets to a remarkable rebound throughout the week.

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