Yip Yap Times

Credit Crunch, Credit Crisis or Just Desserts?

Monday saw a dastardly drop in the Dow average after a very volatile week as turmoil in the U.S. subprime-mortgage shook investor confidence. Tuesday’s market dropped another 200 plus points. Disappointing behavior, but the good news is that yesterday’s drop was due to a less than stellar earnings report from Wal-Mart and Home Depot rather than more panic in the credit market. And we know that Wal-Mart will recover.

The big problem is not so much that some subprime borrowers are delinquent in their payments and may lose their homes, but the uncertainty about who is exposed to these losses. It seems the big hedge funds and financial institutions that were holding a large number of subprime mortgage-backed securities are the ones who are suffering. Their panicky response to the subprime market is causing fears to spread. Last Thursday the French bank BNP Paribas SA stopped withdrawals to the tune of $2.2 billion in three investment funds holding subprime mortgage securities, saying there were so few buyers that they couldn’t determine what these securities were worth. This decision richocheted around the world causing investors to flee from stocks and equity investments.

The American dream is to own one’s own home, but somehow this dream has morphed into a guaranteed right in the minds of some. Hillary and other Democrats are demanding some $1 billion in federal bailouts for those at risk of foreclosure. No one wants to see somebody lose his home; but many of those most at risk bought their homes with little or no money down, and so have very little at stake economically. A government bailout would send the wrong message—that risky borrowing will be rewarded by the government. Those who were wise in their financial decisions are in turn punished by the transfer of their hard earned tax dollars. To the extent that bad loans were made, the market needs to adjust, not be propped up by federal-aid programs.

Greed in the mortgage business overcame the fear that typically guides lenders into common sense loans. Subprime borrowers are typically charged 2 to 3 percent higher rates on their mortgages. Many subprime loans were made to borrowers without proper credit or income checks. Borrowers were enticed with low “teaser” rates in adjustable rate mortgages. As the rates rose and as housing values dropped, these same folks found it hard, if not impossible to refinance. The same judgment on borrowers also applies to the lending institutions. They have to take their licks and that may involve restructuring the loans of delinquent borrowers. This beats the costs of foreclosure.

Amid the market turmoil over leveraged buyouts, margin calls, redemption demands and applications for mortgage loans, the fed has covered liquidity demand. Still, the big and few losers in the lending business are trying to force the government's hand by refusing to conclude deals, make their margin calls and lend money even at higher interest rates. Since debt is the engine for the American economy, these players are claiming a recession unless the fed covers their losses and cuts the short term interest rate. Although the fed can operate as a lender of last resort, its primary dictum is to maintain price stability. Loosening credit at a time when inflation is a real possibility is contrary to that mandate.

It seems that Alan Greenspan’s easy money policy from 2002 to 2005 may have contributed to the current credit creeps. Alan Greenspan’s loose monetary policy was primarily based on the stock market doldrums. The multitudinous rate cuts didn’t boost the stock market so much as created a boon in the housing market, particularly new construction. As demand for housing grew because of extremely favorable mortgage rates, housing values jumped, encouraging people to use their equity as ATM machines. This is profligate behavior that is always roundly punished in the marketplace.

For those who fear recession and for others who fear they will never own a home, it is key to remember that the subprime market is less than 20% of the total mortgage market—and that is a generous figure—and only about 7-8 percent of these are in delinquency. It is a small number. It is miniscule in the total debt market and simply will not dampen economic growth. That is not to say that there won't be pain for low quality borrowers and subprime lenders, but for the overarching economy, it is a pothole. After the shouting stops, people will find that most mortgages were not problematic -- that while some lenders and brokers got too aggressive, the vast majority of loans will be paid off as usual. And hard lessons will be learned so hopefully America won’t see another self-inflicted problem like this again.



Tags: credit crisis credit crisis credit crisis mortgage mortgage mortgage
subprime subprime subprime subprime fed fed fed fed federal reserve
federal reserve hedge funds hedge funds hedge funds,

posted by Lisa @ 7:20 AM