"All things considered, from a market standpoint, a 300-point down day is a relatively small consequence," economist David H. Wang told BloggingStocks Tuesday.
Amid the sell-off, the U.S. Federal Reserve, in an emergency monetary policy action, cut key interest rates Tuesday morning - - cutting both the Fed Funds rate and the discount rate by 75 basis points. The Fed cut the Fed Funds rate to 3.50% and the discount rate to 4.00%.
Larger matter: mortgage insurers
Of utmost importance, in Wang's interpretation, is the health and fate of mortgage insurers, primarily MBIA (NYSE: MBI), and Ambac (NYSE: ABK), but also PMI Group (NYSE: PMI), and MGIC (NYSE: MTG).
Wang said the mortgage insurers "form a critical foundation in mortgage insurance, and as a result, in the mortgage process."
"A failure by MBIA or Ambac would mean several banks would not receive insurance payments for mortgages that go into default, substantially reducing the asset values of those banks," Wang said. "That would prompt another market sell off, possibly resulting in a failure by one or more banks."
Subprime exposure
Wang said he could not specify the dollar amount of at-risk mortgages insured by MBIA and Ambac, but said the total was "most likely considerably higher than $200 billion."
Wang said the U.S. Treasury or U.S. Federal Reserve "will need to undertake a coordinated effort, preferably with major private institutions, to support or buy-out MBIA or Ambac," if it appears a default by either "would threaten the proper functioning of the markets or create financial contagion."
Further, the markets appeared to discount, or sense, that some cash infusion into mortgage insurers was up ahead, as despite the Dow's morning sell-off, the major mortgage insurers rose. MBIA gained $2.20 to $10.75, Ambac surged 2.04 cents to $8.24, MTG gained 46 cents of $14.57, and PMI climbed 15 cents to $6.62.
"The effort to help a mortgage insurer could take the form of major private institutions buying-out the insurer, or infusing capital, or perhaps having a foreign investor, a sovereign, infuse capital," Wang said. "The important thing is that an effort be made to guarantee that these insurers remain solvent. Again, if we don't, we may dodge an insurance bullet today, but we may not tomorrow."
Essential: fiscal stimulus, market liquidity
Economist Steve Affinito agreed with Wang, saying that while Washington has rightfully expended energy putting together a needed fiscal stimulus package to stimulate the U.S. economy, it must not lose sight of the liquidity issues facing the markets, prompted by subprime mortgage and related asset defaults.
"Washington has known about the mortgage insurer issue for at least 2 years, but they've kind of danced around it. Well, there's no dancing around it now, in my view. A failure by MBIA or Ambac would create financial havoc....dragging down institutions for panic reasons, not fundamental reasons," Affinito said, adding that he favored "an effort led by the Fed, or Fannie Mae (NYSE: FNM) or Freddie Mac (NYSE: FRE), to back the insurers, to see that they are able to function as liquid, safe insurers of mortgages."
"Washington and the Fed must remain multi-focused," Affinito said. "We need the stimulus package, longer-term, and we also need to maintain market liquidity, shorter-term. The two go hand-in-hand and are essential to helping the U.S. economy and the nation recover from the subprime mortgage mess."
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