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There can’t be many people out there over the age of 16 who haven’t heard about the US subprime mortgage crisis by now.
For one thing, our beleaguered Prime Minister is now trying to blame said crisis for Britain’s current economic problems. Nothing at all to do with the mistakes (and there were many) he made in the previous 10 years as Chancellor.
Then there’s the fact that the subprime meltdown and ensuing ‘credit crunch’ are now mentioned in almost any press story about the economic slowdown, the housing crash, or poor high street sales over Christmas.
In fact, amid all the focus on the US housing collapse, very few people are looking ahead to what’s coming next.
But that’s a mistake. Because subprime was just the first domino in a whole chain – and we’re about to find out how hard the next set will fall…
We’re getting used to seeing some shocking write-downs from the banking sector – usually accompanied by a coincidental announcement of a massive cash boost from some foreign sugar-daddy, as investment banks are starting to view the sovereign wealth funds. In fact, according to MarketWatch.com, as of the third quarter of 2007, banks had written off a massive $72.3bn in total.
And we’re likely to see more this week, as US banks report on their fourth quarter. Merrill Lynch is expected to write off $15bn on mortgage-related investments that have gone bad. That‘s almost double its original estimate, and according to The Times, it’s now looking for around $4bn from wealthy investors to “shore up its finances”.
Meanwhile, Citigroup is thought to be looking for another $14bn from – well, anyone who can cough up the money really.
Credit card companies start to falter
But the big worry now is that the pain in the housing market is starting to show up in the credit card market. The first clear signs came last week. On Thursday, credit card group Capital One (COF) cut its outlook for the full year and increased its bad debt reserves. Then on Friday, American Express (AXP) issued a full-blown profit warning. The group had to take a $440m hit to cover bad debts for the fourth quarter, and will miss analysts’ hopes for 2008. Its shares fell by around 10%.
As well as rising levels of bad debt, the group blamed slower retail sales. Unsurprisingly, the worst-hit areas were California, Florida and others particularly badly hit by the housing slump. Bloomberg quoted Goldman Sachs analyst James Fotheringham as pointing out the blindingly obvious: “negative earnings trends appear linked to housing, as credit deterioration now couples with geography.” Mr Fotheringham took the radical step of cutting his recommendation on the stock from “buy” to – wait for it – “neutral”.
I’d humbly suggest that “why are you still holding this entirely consumer-dependent stock when we may already be in recession?” would have been a more appropriate rating. But then I’m not an analyst.
In another example of the blind optimism that is the hallmark of a dying bull market, chief executive Daniel Henry had said, back in October that the company’s “affluent and high-spending” clientele would shield it from pain.
It must have come as something of a surprise to him to realise that the affluent were relying on their housing wealth just as much as the poor. But Mr Henry does have one good point – this isn’t a doorstep lender we’re talking about here. If American Express is in trouble, it doesn’t bode well for anyone else in the consumer lending business.
And here’s where we come to the next big problem. The same banks that have already taken a hammering from mortgage-related debt are also up to their necks in plain old consumer debt. The asset-backed securities that have already caused such problems for the banks in the mortgage sector, have also been used to parcel up credit card and car loans.
As The Economist puts it: “A consumer credit slump, which looks increasingly likely, would clobber securities backed by credit-card and car loans.”
The housing slump is in full flow, but the consumer downturn is only just beginning. Yet the world’s investment banks are already having to enter into knockdown deals with foreign suitors to shore up their financial reserves. By the time this cycle is over, a good chunk of America’s banking system (the parts that remain standing, at least) could well be owned from overseas.
The UK’s very own subprime surge
Meanwhile, the latest news from over here is that nearly 20% of all new mortgages written last year were either “subprime” or were “made to a homebuyer who offered no proof of income” reports the FT.
Hmm. And the pundits are still trying to argue that the UK has no subprime problem?
The data comes from the Intermediary Mortgages Lenders Association (which represents mortgage brokers who sell such mortgages). The group’s executive director, Peter Williams, acknowledges that “we didn’t really have a mortgage market for the credit-damaged in the 1980s”. That’s not all. Last time there was a house price crash we had far fewer self-employed people with ‘self-cert’ loans (which are no different to the ‘liar loans’ we keep slating the Americans for). And then of course, there were also far fewer buy-to-letters.
As the FT points out: “The likely fate of these borrowers has not been tested in a recession.”
Well, we’re about to find out what‘ll happen. I suspect it won’t be pretty.
Turning to the wider markets…
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Property stocks limit FTSE losses
In London, the benchmark FTSE 100 ended the day just 20 points lower, at 6,202, as strength in the housebuilding and property sectors offset the effects of steep falls on Wall Street. For a full market report, see: London market close.
On the Continent, the Paris CAC-40 was down 29 points at 5,471, whilst the DAX-30 edged up 4 points to end the day at 7,717 in Frankfurt.
Across the Atlantic, the Dow Jones ended the day 246 points lower, at 12,606, with American Express leading the way. The tech-rich Nasdaq was 48 points lower, at 2,439. And the S&P 500 was down 19 points, at 1,401.
In Asia, the Hang Seng slumped 398 points to 26,468 today. The Japanese market was closed for a holiday.
Gold breaks through $900 barrier
Crude oil had reversed some of Friday’s losses this morning, climbing 40c to $93.09. And in London, Brent spot had risen to $91.46.
Spot gold hit a new all-time high of $906.70 this morning, up from $895.70 in New York late on Friday. Silver, meanwhile, had rallied to a 27-year high of $16.58.
In the currency markets, the pound had risen to 1.9630 against the dollar, but remained near all-time lows against the euro, last trading at 1.3184. And the dollar was at 0.6713 against the euro and 107.75 against the Japanese yen.
And in London this morning, sportswear chain JJB Sports announced that it expects second-half profit to be lower than that for the same period last year. The chain was forced to cut prices by as much as 90% as consumer sentiment turned more cautious. Shares had fallen by as much as 6% in early trade.
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