Credit Crunch
Is the music about to stop with everyone scrambling for a chair? The whole world has been enjoying easy and cheap credit through the globalization of finance, which has tapped the savings of billions of people in the developing countries. This in turn has fueled the longest and strongest period of global growth in modern history, the most spectacular effect of which has been a housing boom allowing millions of people to buy homes they never thought they could afford. But the credit boom, which also inflated the market price of stocks and bonds, is now being superseded by a global credit crunch.
The first pips to squeak have come in what is called the subprime market-home loans made to people with poor credit that were then packaged into pools and sold to investors. For more than a half-dozen years, low interest rates made buying a house such a good deal that some thought prices would rise forever. Lenders relaxed their standards, and borrowers signed for loans that they couldn't afford. The resulting housing bubble is now bursting, leaving us with prices way out of line with reality and an overhang of unsold property and rising defaults. Sales of new homes are down 22 percent below a year ago. More than 20 percent of adjustable rate mortgages are already in negative equity, where the loan is worth more than the property. This will get worse as the low "teaser" rates on mortgages start expiring, especially those taken out last year. The impact of the scary 2006 mortgages won't even be felt until 2008. Some of these loans were given to people with no income, no job, and no assets—so they were called "ninja" loans. According to Credit Suisse, the number of no- or low-documentation loans had increased to 49 percent last year, from 18 percent of all home purchase loans in 2001. Fully a third of all mortgages last year were "nontraditional"—mostly interest-only and adjustable-rate deals that let the borrower defer paying back principal or even increase his loan balance every month. And those who put up less than a 5 percent down payment increased to 46 percent of all home purchases. Five years ago these risky loans were virtually unheard of. Little wonder subprime delinquencies amount to almost 24 percent of the market, up from 15 percent from the same period last year.
The credit squeeze is spreading to home equity loans as well, where even borrowers of prime home equity loans have missed payments at the rate of 5 percent, almost triple a year earlier. And more defaults loom as huge numbers with adjustable interest rates will have to cope with higher payments. The rating agencies don't know how many will miss payments, but the situation is already creating problems in corporate finance. So far this year, the agencies have downgraded billions of dollars in outstanding bonds and warned of possible downgrades in tens of billions more. The reduction in collateral forces lenders to reprice the risks so that the spread between yields on corporate bonds and yields on the riskless U.S. treasury security of the same maturity has widened.
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