I saw an item in a Wall Street Journal email news bulletin–you need to subscribe in order to see the full article, and I don’t–that observed:
A credit bust once seen as isolated to a few subprime-mortgage lenders is beginning to propagate across markets and borders in unpredicted ways and degrees. A system designed to distribute and absorb risk might, instead, have bred it, by making it so easy for investors to buy complex securities they didn’t fully understand. And the interconnectedness of markets could mean that a sudden change in sentiment by investors in all sorts of markets could destabilize the financial system and hurt economic growth.
“Hurt economic growth?” The article on Alternet I saw the other day, which forecast a full-blown depression, is still on my mind. This looks like confirmation, to me.
Today, the San Jose Mercury News begins:
Ripples from the subprime mortgage meltdown are spreading, affecting even borrowers with stellar credit and making popular home equity loans tougher to find.
The latest example: A major national lender stopped approving new home equity loans Monday.
More and more lenders are yanking away loan programs and changing borrowing guidelines as they struggle to please bond market investors, who indirectly provide financing for the nation’s mortgages.
Ohio-based National City Mortgage, one of the nation’s top 10 home equity lenders and one that makes loans through many California mortgage brokers, announced Monday it had “suspended approval” of new home equity loans and lines of credit. The move has no effect on current home equity loan customers, a National City spokesman wrote in an e-mail.
But it may derail home buying plans of borrowers who had been relying on a second mortgage from National City to finance their purchase.
“Lenders are just going out left and right, and that’s causing a lot of havoc,” said San Jose loan broker Doug Jones of Mortgage Magic, referring not just to National City’s announcement, but to the dozens of lenders that have shut their doors for good over the past year and a half. The pace has accelerated again recently.
An e-mail news alert from the Atlanta Journal-Constitution leads to this:
HomeBanc Corp., the Atlanta-based lender that has been hit hard by the housing downturn, said Tuesday it is closing its mortgage loan business and selling some of the assets to Countrywide Financial Corp. . . .
Homebanc becomes another domino in a cascade of failures and cutbacks in the teetering mortgage industry. The impact has roiled the economy, upset stock markets and made buying or selling a house a lot harder. . . .
The announcement comes a day after American Home Mortgage, once one of the nation’s biggest lenders, filed for Chapter 11 bankruptcy protection. Also on Monday, two other large mortgage firms in Houston and Cleveland said they were suspending new loan applications.
This, really, is back to the original scenario, that I commented on earlier. Because at the same time Scott Thill worried on Alternet about a widening crisis in financial markets, which he foresaw leading to a great depression, today’s news renews the specter of homeowners being unable to finance consumerism that has helped keep the economy “booming” amid financial uncertainty.
I am not an economist. I took my last economics class, an introductory macroeconomics class, in Fall 1977 at Sacramento City College.
But I don’t think you have to be an economist to see a double-whammy hitting the economy on both the financial and consumer levels. How bad can it be? It looks like even economists are uncertain. That Wall Street Journal bulletin posting I referred to earlier began:
When the Federal Reserve cut interest rates to the lowest level in a generation to stoke the U.S. housing market and avoid a severe downturn in the wake of the tech-stock decline and the Sept. 11, 2001, terrorist attacks, then-Fed Chairman Alan Greenspan anticipated that making short-term credit so cheap would have unintended consequences. “I don’t know what it is, but we’re doing some damage because this is not the way credit markets should operate,” he and a colleague recall him saying.
Now, as Greg Ip and Jon E. Hilsenrath report, the consequences of moves the Fed and others made are becoming clearer. Low interest rates engineered by central banks and reinforced by a tidal wave of overseas savings boosted home prices and fueled leveraged buyouts. Pension funds and endowments, unhappy with skimpy returns, shoved cash at hedge funds and private-equity firms, which borrowed heavily to make big bets. The instrument of choice: opaque financial instruments that shifted default risk from lenders to global investors.
“Opaque financial instruments?” Scott Thill, again:
“We’ve divorced the system from paper,” explained Overstock.com CEO and hedge fund activist Patrick Byrne to me by phone, “and since then it’s become easier to divorce it from reality. But the problem is that so much has been drained out of the system using these tools that the money is not there. If this gets exposed, the money is not there. It’s been turned into Ferraris and mansions in the Hamptons. It can’t be paid back. The system is going to vapor lock.” . . .
Open up any newspaper to the business section and look for any headlines involving plummeting home sales or declining property values, and you’ll taste the bitter pills, because Bear Stearns is by no means alone. Swiss wealth management powerhouse UBS shuttered its Dillon Read Capital Management hedge fund after losing over $120 million invested in the subprime Kool-Aid. Then there was Amaranth Advisors, which pulled off the biggest hedge fund collapse in history when it blew almost $6 billion of its $9 billion in assets in a mere week after a highly leveraged bet, although it threw its chips down on the price of natural gas
That’s not the housing market, you say? Good point. In fact, the point altogether. . . . Hedge funds spread their bets across the entire economic table, and they are armed with that most virtual of investment strategies.
Martin T. Sosnoff, in a commentary in Forbes, writes:
Shed no tears for the heartburn that’s discomforting banks, brokers, insurance underwriters–anyone connected with buying or selling speculative fixed-income paper. Those who played the yield curve the past few years show burnt fingers now as spreads widened rapidly from below-historic norms of three percentage points to between four and five points even for BB corporate debentures.
Wall Street is in a cement mixer, repricing risk for mortgages, hundreds of billions in bridge loans and collateralized debt. Unfortunately, the stock market is vulnerable. Nobody’s mouthing the “r” word as yet, but some deceleration of gross domestic product momentum is in the cards. The Fed has its eye on mortgage delinquency stats. It wouldn’t surprise me to see them lower Fed funds rates soon to save the housing market from imploding and the economy from recession.
Our present misery dates back to Alan Greenspan’s easy money policy of a few years ago. When the risk-free rate was pegged at 1%, financial market players, starved for higher yields, moved out on the quality spectrum for long maturity goods. Insurance underwriters, brokers, banks and some hedge funds that play the carry trade game have taken hits to their net asset value, but not enough to cripple them permanently.
But Sosnoff, too, compares the situation to the Savings and Loan fiasco of the 1980s:
In the buyout boom of the 1980s, as much as 20% of the market’s appreciation was attributable to deals. Now, there’s a pause in deal mania, until the banks and brokers figure out how to get the bridge loans they had to swallow off their books, repackaging them at higher interest rates. The market is reacting to this turmoil, but it will pass.
There’s always an acceptable clearing price for inventory that’s attractive to richly capitalized new players, individuals and corporations. Mike Milken, where are you?
Milken in the 1980s was working on ways to collateralize debt obligations on everything, to the point where banks’ commercial lending would disappear. Today’s global wealth at an attractive level of return will clear this credit mess.
So I understand this to mean Sosnoff wants to put nearly every borrower on predatory financing at high (some will say usurious) interest rates. This would, at best, delay the day of reckoning. Sosnoff assumes that borrowers at the middle classes and below can afford these rates in the long term. This assumption appears not much different from the assumption behind subprime lending, only on a grander scale, that borrowers would somehow survive to continue to make their payments.
An important difference from the assumption behind subprime lending is that subprime lending made it possible for buyers who otherwise would not be able to obtain financing to buy homes; with a couple years of easy payments under their belts, they expected to refinance on more normal schemes. But Sosnoff apparently would make predatory the norm. If borrowers agree to this, and they may have little choice, the rich will end up owning even more than they already do; it might not be worth much economically, but it would enhance their political power immeasurably.
But Sosnoff may be overoptimistic. He fails to acknowledge that hedge funds are collapsing, not merely losing value, and fails to reckon for the ripple effect that even the Wall Street Journal noted. Sosnoff agrees this is going to hurt, but he thinks the wealthy can afford the losses. And he sounds a note of sympathy for less well-off when he threatens that his “Westchester-Fairfield Dressage Association riders will trash Greenwich, Conn., and all hedge fund plutocrats will be horse-whipped. I advise these money managers to hide in their wine cellars. Their 1982 first growth Bordeaux inventory will be confiscated, earmarked as collateral for families earning under $50,000 with an adjustable-rate mortgage resetting this year.” He’s being facetious of course; he couldn’t make these assumptions unless he were a member of the plutocracy himself.