Credit crisis has Main Street watching Wall Street
The financial credit crisis could affect US consumers.
from the August 13, 2007 edition
Page 2 of 3
• Derivatives – contracts whose value derives from assets like currency or stock – have become a dramatically larger presence in the investment universe. The popularity of mortgage derivatives helped fuel the recent housing boom in the US. The current credit turbulence arose as investors were forced to make huge markdowns on the value of derivatives linked to subprime mortgages (home loans to high-risk borrowers).
• Financial firms are more global. Markets worldwide were shaken last week, and central banks stepped in after a French bank revealed large losses related to subprime US lending. German banks, among others, got caught up in the storm.
• Leverage has grown as investors such as hedge funds and private buyout firms borrow to make their deals. Among the implications: Investors may need to sell even high-quality holdings to cover bets in other areas.
• Ordinary households are touched by financial trends in larger ways. The rise of 401(k) retirement plans has expanded the realm of stock ownership. If employers promise a fixed pension, the funds are likely to be players in hedge fund investing. Borrowing has also increased, with 18 percent of American homeowners' disposable income spent on housing and auto payments, up from 15 percent two decades ago.
Meanwhile, with investors less eager to buy up mortgage loans, lenders have tightened on borrowers. This is typical of any credit squeeze after a boom, but the recent boom was so big that the squeeze could put an unusual amount of downward pressure on home prices over the next year or more.
For most homeowners, their house is their most important financial asset. "This time, they will feel it more" than in past eras of financial-sector tightness, says Rajeev Dhawan, who heads Georgia State University's economic forecasting center in Atlanta.
Just as financial ease fed the housing boom, the end of the housing rush has blown back at financial markets, causing home prices to fall. But unlike in the past, the housing boom faded without the onset of a recession or a significant rise in mortgage rates; the surge in home buying and easy lending simply reached a point where too few buyers remained to sustain the momentum.
Now, as mortgage rates have edged upward, consumers face another financial head wind. More home buyers have been drawn to adjustable-rate loans, rather than loans with fixed rates, in recent years. As those loans reset, the pinch of higher mortgage payments is likely to push foreclosure rates higher, economists say.
The problem: many of the recent adjustable loans came with low "teaser" rates, but payments will reset much higher.
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