Credit Crunch Could Chew Up Lenders
By Peter Eavis
Senior Columnist
12/23/2002 07:01 AM EST
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Credit where credit is not due.
Expect that to be the market's rueful motto in 2003, when the latest tidal wave of lending inevitably starts going bad. Since the economy began slowing back in 2001, banks and other lenders have continued making loans at a breakneck pace, spurred on, of course, by the historically low interest rates set by the Federal Reserve under Alan Greenspan. That poor discipline will come back to haunt financial institutions this year, you can bet.
There have been two overlapping credit bubbles in the last five years. The first mania -- loans to New Economy companies like Enron and WorldCom -- has already gone bust, and lending to such entities has dropped off sharply. But the second fixation -- personal and mortgage loans to consumers -- is still powering forward. Indeed, it has become one of the main drivers behind economic growth, which is why a coming slowdown in consumer loan growth promises to be damaging.
Unsafe at Any Speed
For instance, mortgage loans to households grew 12% from a year ago in the third quarter, hitting $5.85 trillion. That pace of expansion is much faster than that seen at any time during the '90s boom, and marks the fastest growth in 12 years. As a result, the housing market is looking decidedly bubbly.
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Credit Crunch Could Chew Up Lenders
The nation's median existing-home price jumped 9.8% in October from the year-ago period, compared with a 2% rise in inflation. October's increase was the biggest since 1987, according to the National Association of Realtors.
Meanwhile, mortgage delinquencies and foreclosures are at multiyear highs, and unemployment, the main cause of mortgage defaults, unexpectedly rose to 6% in November.
Despite this, financial institutions have continued to focus on borrowers with poor credit -- the so-called subprime market -- even though a number of lenders to this group of debtors have experienced serious problems due to bad loans. Auto and credit card subprime loans have so far been the most frequent source of trouble in the segment.
But look to subprime real estate loans as a trouble spot starting in 2003. A survey by industry journal National Mortgage News said lenders originated a record $60 billion in subprime mortgages during the third quarter. The survey projected more than $220 billion in subprime originations for the year, way in excess of 2001's $180 billion.
Household International (HI:NYSE - news - commentary - research - analysis), estimated to be the nation's largest subprime home lender, decided last month to sell itself to the U.K.'s HSBC (HBC:NYSE - news - commentary - research - analysis) at a price many thought ridiculously cheap. The reason for the low sale price could well have been that managers expected its mortgage book to sour badly.
Toil and Trouble
Hold on, many will say, why should this pace of lending be at all problematic when the economy is recovering? Well, when prices rise mainly because of a big infusion of credit, they are vulnerable to a steep drop when the credit spigot begins to get shut off, as it inevitably will. In other words, there has to be more than credit driving prices higher for a boom to be sustained.
But why can't the credit keep flowing, the bulls will ask? Take a look at the yield curve, which plots the yields on government debt of differing maturities. It is now steep, meaning rates on long-dated bonds are considerably higher than on short-dated notes, an arrangement that is very profitable for lenders.
That slope won't last long, however. Either the economy recovers and short rates move up, crimping banks' margins and pushing up mortgage rates; or long rates come down, which would mean the recovery has stalled, pushing defaults up.
Growing in the Dark
Mortgage Growth Increases During This Slowdown
Source: Federal Reserve, Detox
The Plastic Mountain
Consumer Debt Outstanding (billions, $)
Source: Federal Reserve, Detox
Either way, the housing boom has to stop soon, which will in turn act as a drag on the economy. Indeed, its contribution to economic growth is significant. Goldman Sachs economists estimate that borrowers -- using instruments like mortgage refinance loans -- withdrew $320 billion of equity from their homes on an annualized basis in the third quarter. They also estimate that very little of that amount is being used to pay down other types of debt. As a result, when the mortgage refi boom tapers off, the huge contribution it makes to spending will evaporate and the economy will feel it. What Greenspan and the bulls on Wall Street will never tell you is that an economy can't subsist on credit alone.
(note to see charts click on link then click next page)
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