• News
  • Celebrities
  • Finance
  • Crypto
  • Travel
  • Entertainment
  • Health
  • Others

Credit Crisis Only Begins With Mortgages

Image has not been found. URL: /wp-content/uploads/2008/09/bernanke4.jpgFederal Reserve Chairman Ben Bernanke (WDCPix)

One can pity Federal Reserve Chairman Ben S. Bernanke. No other federal reserve chairman ever cut interest rates by a full 1.25% within just eight days, as Bernanke has done. But the monetary skies remain as leaden and thunder-clouded as ever. The stock market keeps quivering downward, crowds thin at the malls, jobless queues grow. Wal-Mart reports that customers are using their Christmas gift cards for groceries.

Debt-150x150_4614.jpg
Debt-150x150_4614.jpg

Illustration by: Matt Mahurin

The hard reality is that the economy is facing a one-two knockout blow from a collapse in consumer spending, plus a shock-and-awe wave of asset write-downs that is wreaking havoc in the financial sector. The more Bernanke floods the economy with easy money, the worse the final reckoning is likely to be.

First the consumer. For decades, personal consumption’s share of GDP averaged in the 66 percent-67 percent range. In 2000, however, it moved up sharply, hitting 72 percent in early 2007, the highest rate of consumption in any modern country ever.

How did consumers pay for it? Well, not with their wage packet — median household incomes were roughly flat in the 2000s. Instead, households doubled their debt load, and personal savings rates dropped to zero.

Almost all the new borrowing was against houses. Very low interest rates and super-easy mortgage rules drove house prices up 50 percent between 2000 and 2005, one of the fastest jumps in history. As prices soared, consumers refinanced again and again, rolling over the proceeds into pricier houses and more consumption. Wall Street’s economists looked on happily, and constructed elaborate theories proving that the debt spiral could continue indefinitely.

But as outstanding mortgages balances ratcheted higher and higher, they finally smacked up against the ability of homeowners to service their debt, no matter how low the interest. A tipping point was crossed last year, when it dawned on markets that houses were overpriced – and by a whole lot. Home prices are now in free fall; price drops of 20 percent to 30 percent will be required to get them back in line with incomes. Stuck with heavy debt service and no cash left in their homes, consumers are cutting back hard. The credit merry-go-round, in short, has started to run backwards.

The truly bad news is that the credit crisis is not just about home mortgages. The same problems infect almost every important asset class. Commercial mortgages had a drunken spree of their own in 2006 and 2007. A sign of the times: the big New York developer, Harry Macklowe, is unable to pay $7 billion in debt on seven prime Manhattan office buildings he bought less than a year ago. The takeover loans that fueled the 2006-2007 stock market boom are also faltering badly. Trading markets are now pricing prime takeover loans and commercial mortgages as if they were junk bonds.

On quite reasonable assumptions, total market losses from defaults and writedowns on mortgages of all kinds, and from junk bonds, leveraged takeover loans, credit cards, and auto loans, will be in the range of $1 trillion.

(What are “writedowns?” Suppose I pay $1000 for an apparently high-quality 10-year bond that pays 5 percent, or $50, a year. Then, suppose my bond turns out to be riskier than I thought – say, the kind that usually pays 9 percent returns. How much can I sell it for? The answer is about $720; at that price, the $50 in interest equates to a 9 percent yield on the investment. The $1000 bond, that is, has lost 28 percent of its value. If it is held in a bank trading account, the bank would have to reduce its stated profits and equity capital by that amount.)

Roughly half the shaky mortgages and other loans are on the books of banks, with the rest spread among hedge funds, pension funds and individual investors. Banks have already written off $130 billion of bad loans, so they have some $250-$350 billion to go. Reductions in equity capital have about a 10-to-one downward ratchet effect on a bank’s ability to lend.

That is the source of the great “‘credit crunch” that has sent bankers scurrying around the world to Arab, Chinese and other Asian investment funds to replenish their capital. And those are the worries that have pushed the “fiscal stimulus” program through Congress and prodded Bernanke to turn on his fire hose of new money.

The question is, what are we are trying to accomplish? Do we want consumers to keep on spending and borrowing? Are we hoping over-levered companies will pile on more debt? Are we trying to make house prices go up? Isn’t that why we’re in trouble in the first place?

Those questions are the subject of Part II of this article.

Charles R. Morris is the author of “The Trillion-Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash,” which will be out in March. His earlier books include “The Tycoons: How Andrew Carnegie, John D. Rockefeller, Jay Gould and J.P Morgan Invented the American Supereconomy” and “Money, Greed and Risk.”

Discussion & Comments (0)

    Recent Articles

    • Things You Should Know about North America

      Things You Should Know about North America

      Get to know more about North America.

    • Eurovision 2010 Paula Seling Unpredictable Contest

      Eurovision 2010 Paula Seling Unpredictable Contest

      Paula Seling's experience on the Eurovision stage led her to declare that "Eurovision is an unpredictable contest". Which may explain the success of the young Lena from Germany, about whom the predictions before the event did not offer much chances for victory.

    • VIPRow.me - The Best Sports Streaming Website Today

      VIPRow.me - The Best Sports Streaming Website Today

      Have you ever contemplated creating a user-friendly site dedicated to sports-related free live streaming channels?

    • Learn How To Download, Install, And Use The Xnxubd 2022 Frame App

      Learn How To Download, Install, And Use The Xnxubd 2022 Frame App

      XNXUBD 2022 Nvidia users are able to watch thousands of videos and other contents online. XNXUBD 2022 Nvidia New is a piece of software that enables people to watch videos online without having to pay for memberships. On a graphics card, the XNXubd also provides some of the best gaming and virtual reality experiences.

    • Xvideostudio Video Editor Apk Free Download For Pc Full Version In 2022

      Xvideostudio Video Editor Apk Free Download For Pc Full Version In 2022

      A new edition of the Video Editor Apk for xVideostudio.Video Studio has all the latest features, including support for multiple video download formats in HD, FHD, and even 4K resolutions.

    • 9 Best Lotion For Masturbation - Popular Choice For 2022

      9 Best Lotion For Masturbation - Popular Choice For 2022

      Masturbation is a common activity for men and women. It's a natural and risk-free way to explore your body, experience pleasure, and release sexual tension.

    • Reasons Why You Need To Stop Watching Movies From Sflix

      Reasons Why You Need To Stop Watching Movies From Sflix

      Without having to sign up or pay anything, you can watch movies online for free with SFlix. It has more than 10,000 movies and television shows.

    • Coi Leray Mom And Dad's Family History & Wife, Explained

      Coi Leray Mom And Dad's Family History & Wife, Explained

      Coi Leray Collins (born May 11, 1997) is a rapper from the United States. Leray started publishing songs to SoundCloud in 2014, and in 2018 she released her breakthrough track "Huddy" as well as her first mixtape, Everythingcoz.

    • Listen And Download Music On MyFreeMP3 For Free

      Listen And Download Music On MyFreeMP3 For Free

      Are you in a bind and looking for a place to obtain free mp3 songs? Never again will you need to bother, since this article has everything necessary to obtain your solution. Download free music from MyfreeMP3.com, one of the world's most popular websites.