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There’s nothing that government agencies are quite so good at as slamming shut the stable door after the horse has bolted.
The Federal Reserve, the US central bank, gave us a great example of this on Friday, as it warned that lenders in the sub-prime market would have to be much more careful about who they gave money to.
But as we’ve been seeing, it’s too late. They’ve given out as much money as possible to the riskiest prospects they could find. Now that it’s all coming back to haunt them, the Fed’s crackdown is far too little, too late – no one wants to be in the sub-prime business anymore.
The bad news for the wider economy – which the Fed likes to say is going to be just fine – is that it looks like it’s not just the sub-prime borrowers that are defaulting…
It seems that the sub-prime mortgage rot is spreading. Defaults on ‘Alt-A’ mortgages, which stand between prime and sub-prime loans, are also rising.
According to The Times, the value of ‘Alt-A’ mortgages issued last year was $400bn – that compares to just $85bn in 2003. That was about 16% of new mortgages issued that year; the sub-prime market comprised 25%.
Defaults on sub-prime mortgages have risen to close to10%; on Alt-A, they are standing at just 2% – but that’s double the default rate of 12 months ago. David Liu at UBS expects that eventually 1 in 20 of the two million Alt-A mortgages issued last year will default.
But that still leaves the prime market, doesn’t it? All those people who were actually able to provide some evidence of their income, and even had that rarest of things – a clean credit record. Surely they’ll be fine?
Well, unfortunately it’s not quite that simple. In the race to the bottom to lend to sub-prime and near-prime borrowers, lenders lowered standards to the extent that everyone and their dog decided they could buy a house. When you artificially stimulate demand like that, we know what happens next – more demand = higher prices, all the way across the market.
But as dozens of sub-prime lenders go to the wall and the entire industry acquires pariah status, the sub-prime money will dry up. And as it dries up, so will the source of the extra demand – and that means lower prices.
If prices fall, then even the prime borrowers will see their house price tumble – perhaps far enough to push them into negative equity, as has already happened in many parts of the US.
As Adam Compton of RCM Investors tells The Times, if house prices fall, it’s harder for all borrowers to remortgage to cheaper rates if something untoward happens, like a main breadwinner losing their job, for example.
And job losses are likely – the housing market has been both a major driver of consumption, allowing people to use their houses as an apparently endless line of credit; and a major driver of employment, through construction, property sales, and all the sundry jobs associated with a property boom.
As house prices continue to fall, Americans are heading for a double-whammy – which we’re already seeing – of falling consumption (which means falling profits, which means redundancies) and falling employment, which will feed on each other in a vicious downward spiral.
When will it end? Who can tell – but the pain will be felt far beyond the sub-prime sector before this particular ‘correction’ ends.
Turning to the stock markets…
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The FTSE 100 closed 0.2 points higher on Friday at 6,116, after hopes of M&A activity helped calm investors nerves following a week of selling in the markets. One of the big movers was Scottish & Southern Energy, up 48 pence to 1,465 after Gazprom was rumoured to be making a bid for the utility. For a full market report, see: London market close
Elsewhere in Europe, the Paris CAC-40 ended the day 34 points lower, at 5,424, whilst the Frankfurt DAX-30 slipped 0.6% at 6603.
On Wall Street, the Dow Jones recorded its worst weekly performance in more than four years as the yen rallied against the dollar amid continuing concerns over the US economy. The Dow fell 120 points on Friday to close at 12,114. Meanwhile the S&P 500 closed 16 points lower, at 1,387 while the Nasdaq fell 36 points to 2,368.
In Asia, the Nikkei was 575 points lower at 16,642.
U.S. crude oil was 62 cents lower on Friday at $61.64. Brent spot was 3 cents lower, at $62.08.
Spot gold was trading at $651.90 this morning.
And in the markets today, shares in Europe and Asia continue to slide as last weeks sell of enters its second week. Japans Nikkei closed 3.4% lower on Monday, while the FTSE 100 was 86 points lower at 6,031 by 0825 GMT.
And our two recommended articles for today…
The dangers of economic complacency
-While politicians increasingly embrace protectionist policies, they are ignoring a much greater risk to their economies – and global economy in general. For more on how central banks are fuelling a global risk binge which will end in a nasty hangover, see: The dangers of economic complacency
Why carry trade investors should be getting nervous
– Speculators have been profiting from low Japanese interest rates and the weak Yen, but recent rate hikes mean the rules of the game are changing. To find out what will happen when everyone begins to rush to the exits, read: Why carry trade investors should be getting nervous