Thursday, February 14, 2008

Mortgage Crisis Spreads

U.S. Mortgage Crisis Spreads Beyond Subprime Loans

By Vikas Bajaj and Louise Story | 14 February 2008

NEW YORK— The U.S. credit crisis is no longer just a subprime mortgage problem.

Click Here, or on the image, to see a larger, undistorted image.

Brenda Harris at her Las Vegas home that she bought for $392,000 in 2006. The value has since dropped while her mortgage payments may have to increase by 50 percent. (Isaac Brekken for the New York Times)

As the world's largest economy grapples with the worst housing slump in two decades [[three-quarters of a century!?!: normxxx]], people with good credit histories are falling behind on house payments, auto loans and credit cards at an accelerating pace. The problem, spurred by a sharp decline in home prices and a clampdown on loans by banks, poses a new a threat to the housing market and weakening economy, which some specialists say is already in a recession or headed for one.

The Bush administration, scrambling to keep the U.S. economy from skidding too sharply, on Tuesday released [yet another] plan to help 'qualified' homeowners in distress hang on to their homes. The initiative was announced as Warren Buffett, the billionaire investor, offered to reinsure the municipal bond portfolios of three troubled bond guarantors, a move that, together with the Bush plan, bouyed Wall Street investors searching for any good news about the troubled mortgage market.

But Buffett's offer, already rejected by one of the companies, would do little to alleviate the problems they are facing on the guarantees they have made to investors who hold securities backed by mortgages, consumer loans and other assets. Until recently, people with prime credit histories, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the strains posed to the U.S. economy by rising defaults among borrowers with blemished, or subprime, credit.

"This collapse in housing value is sucking in all borrowers," [[except for the upper 1%, who have had more than enough tax relief in the last 7 years to cover almost any losses: normxxx]] said Mark Zandi, chief economist at Moody's Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later [[aka 'ARMs', with 'teaser' rates up front: normxxx]]. As long as home prices were rising, borrowers on these terms could refinance their loans or sell their properties to pay off their mortgages on reset.

Although the rise in prime delinquencies is less severe than the one in the subprime market, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit. "Subprime was a symptom of the problem," said James Keegan, a bond portfolio manager at American Century Investments, a mutual fund company. "The problem was, we had a debt or credit bubble." The bursting of that bubble has led to steep losses across the financial industry. American International Group said Monday that auditors found it "might have" understated losses on complex financial instruments linked to mortgages and corporate loans.

The turmoil is also stirring fears that some hedge funds may[!?!] run into serious trouble.

At the end of September, nearly 4 percent of prime mortgages were past due or in foreclosure, according to the Mortgage Bankers Association. That was the highest rate since the group started tracking prime and subprime mortgages separately in 1998. The delinquency and foreclosure rate for all mortgages, 7.3 percent, is higher than at any time since the group started tracking that data in 1979, largely as a result of the surge in subprime lending during the past few years. Personal bankruptcy filings, which fell significantly after a 2005 law made it harder to wipe out debts in bankruptcy, are also starting to inch up again.

An example of the spreading credit crisis is Don Doyle, a computer engineer at Lockheed Martin who makes a six-figure income and had a stellar credit score in 2004, when he refinanced his home in northern California to take cash out to pay for his daughter's college tuition [[obviously NOT in the upper 1%— maybe the upper 5%!?!: normxxx]]. Doyle, 52, is now worried that he will have to file for bankruptcy because he cannot afford to make the higher, variable payments on his mortgage, and he cannot sell his home for more than his $740,000 mortgage. During the past few years, his mortgage rate rose as high as 7.5 percent, up from an original 3.8 percent, but he managed to negotiate it down to 5.6 percent, where it is now. That new rate, however, is set to rise in the next few months. "The whole plan was to get out" before his rate reset, he said. "Now, I am caught. I can't sell my house. I'm having a hard time refinancing. I've avoided bankruptcy for months, trying to pull this out of my savings."

The program announced Tuesday by the Bush administration, crafted by six of the largest U.S. lenders, would offer both prime and subprime borrowers who are more than three months behind with their payments the chance to halt foreclosure proceedings for 30 days and work out new loan terms [[a joke, right? W is desperately trying to stall until January— I doubt if he can pull it off: normxxx]]. Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo will contact homeowners who are 90 or more days overdue on monthly mortgage payments to work out a way to make the mortgage more affordable[!?!]

In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appeared to be giving up on their homes as prices fell, noting a "change in social attitudes toward default." The default rate for prime mortgages is still far lower than for subprime loans, about 24 percent of which are delinquent or in foreclosure. Some economists note that slightly more than a third of American homeowners have paid off their mortgages completely. This group is generally more affluent and contributes more to consumer spending and the economy relative to its size.

Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have greater means to restructure their debts if they lose their jobs or encounter other financial challenges. The recent reductions in short-term interest rates by the Federal Reserve should also help by reducing the reset rate for adjustable-rate loans[!?!] [[they've got to be kidding if they think that a percentage point or two off of a doubling of interest rates for the homeowner will do it! : normxxx]] Economists say the rate cuts and the stimulus package are unlikely to make a significant dent in Americans' huge debts, because banks have tightened lending standards, and expected rebates from the government will not cover most house payments [[nor even half of one!: normxxx]].

Depression Risk Might Force U.S. To Buy Assets

By John Parry | 14 February 2008

2/13/08 | New York (Reuters)Fear that a hobbled banking sector may set off another Great Depression could force the U.S. government and Federal Reserve to take the unprecedented step of buying a broad range of assets, including stocks, according to one of the most bearish market analysts.

That extreme scenario, which would aim to stave off deflation and stabilize the economy, is evolving as the base case for Bernard Connolly, global strategist at Banque AIG in London. In the late 1980s and early 1990's Connolly worked for the European Commission analyzing the European monetary system in the run up to the introduction of the euro currency. "Avoiding a depression is, unfortunately, going to have to involve either a large, quasi-permanent increase in the budget deficit— preferably tax cuts— or restoring overvaluation of equity prices," Connolly said on Monday.

"If conventional monetary policy is not enough to produce that result, the government may have to buy equities, financed by the Fed," Connolly said. Legal changes would be needed to give the Federal Reserve and the U.S. government the authority to buy stocks. Currently the Federal Reserve can buy only debt issued by the Treasury, as well as U.S. agency debentures and mortgage-backed securities [[however, I believe there is an "extraordinary" powers clause, enacted in the '30s, which empowers them to buy just about anything: normxxx]]. While Connolly already sees some parallels with the 1930s, he expects that a more pro-active central bank and government would probably help avert a repeat of that scenario today.

The build up of a credit bubble in recent years was similar to the late 1920s run-up to the Great Depression, he said. Then, as now, investors were very optimistic about new technologies, and stocks rose against a backdrop of low inflation and a strong trend toward globalization. There was even an equivalent of the modern day mortgage debt meltdown in the form of U.S. loans to Latin American countries which had to be written off and a severe collapse of the Florida housing bubble in 1926.

"The big difference is the attitude of central banks and specifically the attitude of the Fed," Connolly said. Some economists have blamed the U.S. economy's travails in the 1930s on the Federal Reserve's hesitation to inject reserves into the banking system [[they certainly don't want to be so accused today, judging by the huge injections of liquidity in the form of 'loans' and the acceptance of near zero-value collateral at face value so far: normxxx]]. Today's Fed has tried to preempt the danger of a protracted economic slump, and has reacted swiftly to a [still developing] credit crunch and gathering signs of deterioration in the economy in the past year, Connolly said.

The Fed has stepped up its temporary additions of [liquidity] to the banking system, and swiftly slashed its benchmark fed funds target rate to 3.0 percent from 5.25 percent in September. Analysts expect at least another 0.5 percentage point cut next month.

At the same time, "the fed funds rate can't stay significantly above the 2-year note yield" [indefinitely], Connolly said. On Tuesday, the 2-year Treasury note yield was at 2.00 percent, not far above the lowest level since 2004. The Fed "almost certainly" has to cut the funds rate to 2.0 percent by the end of this monetary easing cycle, he said. If conditions in the banking sector worsen, the Fed could cut the funds rate to 1.0 percent, a low last seen in June 2004 [[and which would probably signal total collapse of the financial system, this time around: normxxx]].

Global banks have already written down more than $100 billion of bad debts associated with the U.S. subprime mortgage debt meltdown and housing market decline. However, Fed rate cuts alone are unlikely to avert a prolonged period of economic weakness because the danger still exists that a burdened banking sector will choke off credit to consumers and households. "The Fed probably can't fix it all on its own now," Connolly said. "There is a chance the Fed gets forced into unconventional cooperation with government," which could involve buying a range of assets to reflate their value.

That would be reminiscent of some steps the U.S. government took in the 1930s when the economy was mired in deflation and high unemployment. One turning point came when agricultural prices were restored to their pre-slump levels, Connolly said. Such measures were among the New Deal programs that President Franklin D. Roosevelt launched to bolster the economy [[and which only served to freeze bad debts into place, and prevent their speedy writeoff as in the Savings and Loan fiasco: normxxx]]. Either way, investors face bleak prospects now without some kind of further government intervention, he said.

Those steps might offer clues to investors in stocks and commodities, which Connolly expects the government might ultimately be forced to step in and buy to 'stabilize' markets. He expects that a depression may be averted, but only by the state and the Fed reinflating the price of such assets[!?!] [[that's the worst possible outcome and could move us from a severe recession into a prolonged depression, as in the '30s: normxxx]]. Beleaguered housing, non-government fixed-income securities and even the now overvalued Treasury market have little hope of generating substantial returns for investors over the next few years, he said.

"And, of course, if we don't avoid depression, the only thing worth holding is cash," he added [[or Gold!?!: normxxx]].

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