Wilting in a Market Meltdown
As credit dries up, fears of recession spook investors
The subprime mortgage mess that roiled the nation's credit market is now threatening one of the longest uninterrupted bull runs in stocks. Investors are waiting for the next domino to fall, as government officials warned last week that the housing-related financial crisis is likely to slow U.S. economic growth.
Near the end of one of the most nervous weeks on Wall Street in years--one in which housing starts plummeted to their lowest level in a decade--the stock market officially fell into a "correction," a decline of 10 percent or more. It was the first such drop since the last bear market ended in October 2002, which means that this financial crisis did something that neither the Iraq war nor record oil prices could.
The Dow Jones industrial average slipped well below the 13,000 level after trading above 14,000 as recently as July 19. Shares of mortgage-related businesses like Countrywide Financial and KKR Financial took big hits amid growing concerns about a credit crunch in the economy. Countrywide, one of the largest players in mortgage originations, was forced to tap an $11.5 billion reserve line of credit because, like so many other financial firms, it was struggling to raise funds through its mortgage-backed securities.
What's so frightening about this sell-off is that "it's impossible to tell where you are," says Howard Silverblatt, senior analyst with Standard & Poor's. "We could be right at the bottom just before things head up, or we could be in a free fall."
Last week, it felt more like a free fall.
Fixed-income investors have already felt the effects of the credit crunch, as holders of certain types of mortgage-backed securities have seen their investments plunge in value amid rising problems in the subprime market, which caters to borrowers with poor credit histories.
Home sales continue to decline, as potential buyers have begun to feel the effects of this crunch. Credit checks are getting more stringent, and interest rates on big home loans are rising. A report last week showed home-builder confidence at its lowest level in 16 years.
As aggressive lenders turned downright timid, the equity markets started to wilt.
"There are two things going on in the equity markets," says Mark Zandi, chief economist for Moody's Economy.com. "One is the realization that private equity, which relied on cheap credit to fuel its activities, is not going to provide the juice to equity prices that it has in the recent past." The other, Zandi adds, is that Wall Street is now considering how the weakening housing market will affect the broader economy. Treasury Secretary Henry Paulson told the Wall Street Journal that the sector's troubles will "extract a penalty" on growth but not cause a recession. But many investors think a downturn is more likely now than just a couple of weeks ago.
Indeed, the mortgage crisis especially threatens the profits of financial-services companies, already under pressure. Today, financial stocks represent more than 20 percent of the Standard & Poor's 500 index. That makes financial services the most influential sector in the market.
advertisement
