Saturday, August 18, 2007

Few Heard Ticking Credit Time Bomb

I believe things are going to get much worse in the credit melt down before they get better. We have received three alerts from out title underwriter in the last two days advising NOT to schedule loan transactions with certain lenders due to those lenders' recent difficulties funding loans. This somewhat lengthy article in today's New York Times ( makes it clear that warning signs were there for some time. People simply chose to ignore them and got away with it until the house market slow down became pronounced. Locally, foreclosures have doubled from a year ago. Here are some highlights from the Times article:

All through last year, Jim Melcher saw the signs of a rapidly deteriorating American housing market — riskier mortgages, rising delinquencies and more homes falling into foreclosure. And with $100 million in assets at his hedge fund, Balestra Capital, he was in a position to do something about it.

So in October, as mortgage-backed bonds were still flying high, he bet $10 million that these bonds would plunge in value, using complex derivatives available to any institutional investor. As his gamble began to pay off in the first months of 2007, Mr. Melcher, a New York-based money manager, plowed the profits into ever bigger wagers that the mortgage crisis would worsen further, eventually risking some $60 million of the fund’s money.
In December, the first subprime lenders started failing as more borrowers began falling behind on payments, often shortly after they received the loans. And in February, HSBC, the large British bank, said it would write off $2 billion in losses from its American subprime lending business. Over the last two weeks, this slowly building wave became a tsunami in the global financial markets.

On Friday, the Federal Reserve was forced into a surprise cut of the discount rate it charges banks to borrow money, steadying shaky stock and credit markets and reassuring investors, bankers and traders who were reeling from a month of market turmoil. And for the first time, the Fed bluntly acknowledged that the credit crisis posed a threat to economic growth. “Until recently, there was a lot of denial, but this is a big deal,” said Byron R. Wien, a 40-year veteran of Wall Street who is now chief investment strategist at Pequot Capital. “Now the big question is: Will this spill over into the broader economy?”

“All of the old-timers knew that subprime mortgages were what we called neutron loans — they killed the people and left the houses,” said Louis S. Barnes, 58, a partner at Boulder West, a mortgage banking firm in Lafayette, Colo. “The deals made in 2005 and 2006 were going to run into trouble because the credit pendulum at the time was stuck at easy.”

Other companies face far more immediate problems. Countrywide Financial, the nation’s largest independent mortgage lender, found itself defending reports this month that bankruptcy could be looming as its stock plunged 41 percent. To make matters worse, all borrowers are now likely to face higher borrowing costs for years to come, even those with stellar credit histories. Already, mortgages of more than $417,000, known as jumbos, carry interest rates of 7.5 to 8 percent, up from 6.5 percent last month.

What is more, subprime mortgages offered to homebuyers in 2005 and 2006, when credit standards were at their most lax, will soon begin to reset, forcing up monthly payments for the weakest borrowers practically overnight. As a result, Mr. Goldstone predicts that banks and other lenders could eventually see losses reach into the tens of billions.

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