Credit Crunch
Not-so-easy money. Banks that got into the easy-lending mode are reverting to the days when they avoided the riskier (and more profitable) loans. But the biggest problem is that many cannot offload the loans they wish they'd never made; they will have to live with them for a long time. It is this inability of the large banks to syndicate—sell off—their leveraged loans that is causing the credit markets to freeze up.
With housing prices falling for the first time since 1991, a chain reaction has begun. Bundled mortgages sold to investors as interest-paying bonds are falling in value. Major credit rating firms warn that loan delinquencies may be much worse than anticipated because when homes become worth less than the loan, the owners cannot sell or refinance their way out of trouble. This confirms the caution I urged on home buyers in an editorial in May 2006.
With more than $1.8 trillion worth of securities backed by subprime mortgages created since 2000, banks and investors are suffering losses that are exposed every week, affecting the overall confidence in the credit markets.
The housing boom was dependent on these relatively reckless loans that pushed home prices to levels far above what many current and would-be owners could afford, and the risk of a further, nationwide decline in home prices will inflict real hardship on millions of Americans.
On the plus side, employment levels remain strong, and people do not tend to give back the keys to their homes while they still have jobs. But lending terms are getting tighter, financial investors are becoming increasingly risk averse, and the liquidity tap is being turned down, or even off, raising the prospect of an economic downturn before the end of this year.
No wonder speculation is growing that the Federal Reserve will have to lower interest rates to contain the damage to the overall economy.
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