International Herald Tribune – Trapped in a vicious credit crunch By Vikas Bajaj Tuesday, July 1, 2008
Many policy makers and bankers said the credit mess was contained.
Boy, were they incorrect. More than a year after the crisis first flared, the U.S. financial industry, and with it the broader economy, seems to be caught in a vicious circle.
As home prices sink, Americans are falling behind on their mortgages in growing numbers. As more homeowners run into distress, banks must write off even more loans. And as the terrible loans mount, financial companies are increasingly unable or unwilling to extend credit, making it even harder to buy homes or expand businesses.This process is playing out painfully on Wall Street, where on Monday the stock market rounded out its worst 12-month run since the spring of 2003, when the United States invaded Iraq and the market was beginning a tenuous recovery from the bursting of the technology bubble. The Standard & Poor’s 500 is down 12.8 percent for the first half of the year. The index just had its worst June (down 8.6 percent) since 1930 (down 16.5 percent). The Dow Jones industrial average is off 14.4 percent for the first half of the year. Financial shares keep falling. Even as the broader market posted a small gain Monday, shares of banks and brokerage firms in the S&P 500 fell 2.1 percent, to a five-year low. The share price of Lehman Brothers, which has been struggling to persuade investors that it can survive as an independent firm, fell 11 percent Monday, bringing its loss for the year to nearly 70 percent.
"Eventually, the financial sector’s troubles will be communicated to the rest of the economy," said Douglas Peta, market strategist at J&W Seligman in New York. "As there is less investment available that restrains consumer spending, it restrains corporate spending. "One measure already signals that the woes of the financial system are straining the economy. In the last 13 weeks, total bank loans, leases and securities holdings have fallen at an annual rate of 9.1 percent, its fastest decline since 1973, when the data was first collected, according to Jan Hatzius, chief domestic economist at Goldman Sachs.
Even as the Federal Reserve and the government have tried to reinvigorate the economy with lower small-term interest rates and tax rebates, rates on mortgages and corporate loans have risen to their highest levels this year.Until recently, "we haven’t had the sense that we had the downward spiral in anything other than housing," said Jane Caron, chief economic strategist at Dwight Asset Management, a bond-trading firm based in Burlington, Vermont. "What I am worried about is that we are headed in a direction where those negative feedback loops expand and intensify.
"That cycle will not be broken, Caron and other analysts say, until the decline in home prices slows significantly or ends, allowing the market to tally the full cost of the recent credit binge and restoring confidence among bankers and investors.
Some analysts see tentative signs that the fall in housing may be
ebbing. Sales of existing homes have flattened in recent months and
home prices fell a small less in April than they did in March on a
month-over-month basis. But both trends could easily reverse, as they
have after previous upswings.
"We could reach a bottom in housing at
the end of this year and have some growth in the second half of 2009,"
Caron said, "but that requires the economic backdrop to remain no worse
than it currently is. "Another strain on the economy and markets is the
rapid rise in the prices for energy, food and other commodities. Crude
oil prices are up about 51 percent this year and corn prices are up 55
percent. That increase in raw material prices is one reason that
quick-growing markets like China and India – which are increasingly
dependent on energy imports – have taken a beating in recent months.
For the American markets, the rise in prices is certainly vital,
but spending on energy and food makes up a relatively small part of the
average family’s income. Much more vital, analysts say, is the
ability to borrow money to buy homes and expand businesses.In addition
to paying higher interest rates, borrowers are also dealing with more
restrictive lending standards. Recently, Fannie Mae, for instance,
tightened its rules for real estate investors buying multiple homes,
which the owners typically rent out. In the past, the company allowed
investors to borrow against up to 10 properties. Now, it limits them to
four. "That immediately knocked out a large supply of people who were
prepared to buy these homes," said Lou Barnes, a mortgage broker based
in Boulder, Colorado, referring to foreclosed or vacant homes. He
added, "The main reason for suppressed prices of homes is the
difficulty of financing them. "
Those tougher conditions may remain in
place for a while. The financial system is being forced to undo the
excesses of recent years and return to a more sustainable level of debt
in the economy, said Marc Stern, chief investment officer at Bessemer
Trust, an investment firm in New York. "This is not just another
cycle," Stern said. "It’s the end of a period of rampant leverage and
lax lending standards, and that takes a bit of time to work through."
Trapped in a vicious credit crunch – Print Version – International Herald Tribune
Tags: credit, mortgage, housing crisis, foreclosure, fannie mae, Lehman Brothers, bank, interest rates, foreclosure, real estate, investors
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