This feature is part of our FREE daily Money Morning email. If you’d like to sign up, please click here: sign up for
Money Morning
Global markets seem to be recovering rather quickly from their little blip earlier this month. In these days of perpetual sunshine and easy money, it seems that nothing can keep investors rattled for long.
But there’s one dingy corner of the world economy where the shadows just keep on expanding and the news just keeps getting worse.
Everyone is still happily pretending that the US sub-prime credit monster will remain confined to its little corner, tearing apart the lives of the poor and the destitute and the economically inconsequential – after all, most of these people shouldn’t even have been on the property ladder in the first place, should they?
But of course, the monster is also consuming those who were greedy and stupid enough to dish the money out in the first place. And the latest casualty should make investors think twice about their rosy hopes for the US economy…
The casualty list of US mortgage lenders that have gone bust since late 2006 has now hit 36, according to The Mortgage Lender Implode-O-Meter. And the latest casualty seems very likely to be New Century Financial, the third-biggest sub-prime lender in the US.
Shares in the firm have been suspended after it reported that its lenders are cutting off its credit lines, while it also doesn’t have enough money to repay all its outstanding obligations. We’ve discussed this before, but to recap – big investment banks, like Morgan Stanley, gave companies like New Century credit lines from which to write mortgage business. New Century then sold these loans – via the investment banks – to investors in the form of bonds called Mortgage-Backed Securities (MBS).
The one snag was that the MBSs had a clause in them saying that if they went bad more quickly and severely than expected, the buyers could demand a refund. That’s exactly what’s happened, and now that loans are being bounced back in droves, the company no longer has the money for refunds. That means there’s a very good chance it will have to file for bankruptcy.
Other lenders are tidying up their acts rapidly, in the hope that they won’t go the same way. Countrywide Financial, the main US mortgage lender, has already told its brokers “to stop offering borrowers the option of no-money-down home loans” reports Reuters. That’s bad news for the entire housing market.
At the end of last week, Dale Westhoff, head of mortgage-backed research at Bear Stearns, estimated that 1.1m borrowers could be locked out of the US housing market this year because of tightening lending criteria. Lenders are sharply cutting back on the amount of money loaned to the sub-prime and “Alt-A” (mortgages where there isn’t enough proof of income, basically, to be considered prime) markets.
“That’s a non-trivial number,” he said at a Bear Stearns mortgage conference, somewhat unnecessarily. He reckons the sub-prime sector will shrink by nearly a third this year, down by $180bn, while Alt-A lending will fall by 25%, or $100bn.
And if fewer people are propping up the bottom end of the housing market, falling demand means prices will keep falling too. If the slump is anything like the last one in 1991, says Robert Kleinheinz of the California Association of Realtors, it will go on for another year “and may fuel a recession”, reports Bloomberg.
Between July 1989 and January 1991, new home sales fell 45% and 1.1m US jobs were lost. So far this time round, new-home sales have fallen 28% since September 2005. As for job losses – housing and related industries, which account for about 23% of the US economy, laid off 100,000 people last year. This year could be much worse – New Century alone employs 7,000 staff.
Then of course, there’s the impact on the investment banks. They have, after all, been bankrolling and then selling on the loans created by the sub-prime lenders – in effect, the lenders have been a bad credit arm of the investment banks. And the markets have noticed – stocks and bonds in the sector are being marked down. For more on this, read Adrian Ash’s recent piece: How (not) to fix a housing crash.
As if that wasn’t enough, there’s also now the threat of increased regulation hanging over the market – which all the brokers pushing interest-only loans onto naïve first-time buyers over here should keep an eye on. As Josh Rosner of investment research firm Graham-Fisher & Co. recently told The New York Times, “This is far more dramatic than what led to Sarbanes-Oxley.” And we all know what Sarbanes-Oxley did for the US stock market.
All of this adds up to a much longer housing slump than anyone is currently expecting. As Edward Leamer of UCLA Anderson Forecast in Los Angeles tells Bloomberg: “The market needs new money in order to appreciate, and all that money is gone for a very long time. The regulators are not going to allow it to happen again.”
Turning to the stock markets…
Enjoying this article?
Why not sign up to receive Money Morning FREE every weekday? Just click here:
FREE daily Money Morning email
.
The FTSE 100 closed 11 points lower, at 6,233, yesterday as further gains for takeover target Alliance Boots failed to offset investor fears of further rate hikes and weakness elsewhere in the retail sector. For a full market report, see: London market close
Elsewhere in Europe, the CAC-40 ended the day 41 points lower, at 5,496, and the Frankfurt DAX-30 was 1 point lower, at 6,715.
Across the Atlantic, stocks ended the day higher as investors were encouraged by a spate of high-profile mergers. The Dow Jones rose 42 points to end yesterday’s session at 12,318. The Nasdaq gained 14 points, closing at 2,402, and the S&P 500 closed at 1,406, a 3-point gain.
In Asia, the Nikkei ended its winning streak yesterday, falling 113 points to end the day at 17,178.
Crude oil was little changed at $59.08 this morning, and Brent spot was 51c higher at $60.63 in London.
Spot gold had recovered from yesteray’s $3 plunge this morning and was last quoted at $650.50, compared to $647.00 in New York late last night. Silver, meanwhile, was trading at $12.98.
And in London this morning, the Royal Institute of Chartered Surveyors (RICS) announced that house prices had risen at their slowest pace for nine months in February. A spokesman for RICS said that interest rate hikes had ‘started to worry’ would-be buyers who were concerned they would be unable to meet mortgage repayments. The survey also revealed that the number of people registering to browse properties had fallen to a two-year low.
And our two recommended articles for today…
Why China needs to speed up financial reform
– A key question for the National People’s Congress of China as it meets this week is: what comes next? Many think that the answer lies with the Chinese consumer, but China faces other obstacles on the road to rebalancing in the form of state controls and slow banking reforms. For Stephen Roach’s assessment of the main issues currently facing the economy, read:
Why China needs to speed up financial reform
Key challenges to stock market stability
– Despite recent sell-offs, the long-overdue correction is still overdue. Find out what the greatest potential disruptions to the market are, what the technical indicators are telling us – and why you should keep an eye on the Dow – by clicking here:
Key challenges to stock market stability