Tuesday, September 08, 2009

Credit contraction and mortgage markets

The consumer continues to retrench and that was demonstrated by the record plunge in July's consumer credit.

"Consumer credit fell by a record $21.6 billion, or 10 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington.

Credit dropped by $15.5 billion in June, more than previously estimated. Credit fell for a sixth month, the longest series of declines since 1991.The arrival of the government’s “cash for clunkers” program in late July wasn’t enough to keep credit that covers car loans from plummeting by a record amount, as consumers delayed other purchases.

Economists had forecast consumer credit would drop $4 billion in July, according to the median of 31 estimates in a Bloomberg News survey."

This has far reaching implications for retail this fall as we head into the holiday shopping season. If the access to credit still shrinks while consumers experience a weak job market the prospects for spending will be bleak.

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I think we've all been aware of the growing role that the Federal Government was taking in the housing market but the flood of data over the past few days has really shed substantial light on just how large of a role the government is playing.

Only one lender of consequence remains: the federal government, which undertook one of its earliest and most dramatic rescues of the financial crisis by seizing control a year ago of the two largest mortgage finance companies in the world, Fannie Mae and Freddie Mac.

While this made it possible for many borrowers to keep getting loans and helped protect the housing market from further damage, the government's newly dominant role -- nearly 90 percent of all new home loans are funded or guaranteed by taxpayers -- has far-reaching consequences for prospective home buyers and taxpayers.

The government has the power to decide who is qualified for a loan and who is not. As a result, many borrowers among both poor and rich are frozen out of the market.

Nearly one-third of those who obtained home loans during the boom years of 2005 and 2006 couldn't get one today, according to mortgage industry analysts. Many of these borrowers were never really able to afford their homes and should not have gotten loans. But many others could, and borrowers like them are now running into tougher government standards.

At the same time, taxpayers are on the hook for most of the loans that are still being made if they go bad. And they are also on the line for any losses in the massive portfolios of old loans at Fannie Mae and Freddie Mac, which own or back more than $5 trillion in mortgages.

There is growing evidence that many loans being guaranteed by the government have a significant risk of defaulting. Delinquencies are spiking. And the Federal Housing Administration, another source of government support for home loans, is quickly eating through its financial cushion as losses mount.

The outlay has already reached about $1 trillion over the past year and is rising. During that time, the government has pumped more money into the mortgage market than has been spent on Medicare or Social Security or the defense budget, more even than Washington has paid to bail out banks and other struggling companies.

"Absent government intervention, there would be no lending," said Nicolas P. Retsinas, director of Harvard University's center for housing studies." Washington Post

I'll leave it to the talking heads on TV to debate the value of government intervention in these markets, but my issue is with the fact that we appear to have not learned any lessons over the past 4 years. If the government wants to be in the mortgage business - great, but lets make sure we don't repeat the same mistakes by lending to people that can't afford their homes if rates go up or if they lose their job or will walk away if the house value falls 8 percent because they only put 3 percent down. Ooops, too late.

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