Slate Magazine moneybox Debt Be Not Proud The subprime mess is just the beginning of the credit crunch.
By Daniel Gross Posted Thursday, Dec. 6, 2007, at 6:23 PM ET The stock market rallied today after President Bush announced a deal under which mortgage lenders would cut subprime borrowers some slack and freeze rates. As such, it represents the latest effort by the financial-industrial complex to draw a bottom line under the spreading credit woes. With this action, the market seems to have concluded, the negative effects of the subprime mess may finally be contained. I hate to be the bearer of bad news, but the subprime flood—which has been declared contained over and over again—isn't contained yet. Newsweek's Daniel McGinn ably explains why the rate freeze is far from a panacea for all subprime borrowers. And a flood of new data indicate that the subprime woes may be a symptom—rather than a cause—of a broader economic malady. That awful smell in Midtown isn't from the horse-drawn carriages carrying tourists around. It's the distinctive odor of debt going bad. We've just ended a bubble in housing, in housing-related credit, and in all other types of credit. Low interest rates, competition for market share, the continual pooh-poohing of inflation, and the widespread use of securitization spurred banks and mortgage companies to lend with abandon. Any risk associated with lending could be ironed out by slicing and dicing debt and selling it to investors, who could in turn hedge their exposure to the debt through derivatives. Any remaining risk would be wiped out by growth, perpetually rising asset prices, and a willingness of other lenders to refinance existing debt on favorable terms. And so credit was available on easy terms to people in all walks of life: home buyers and real estate developers, car buyers and college students, consumers and private equity firms. Today, however, the assumptions holding up the latticework of credit are coming apart, one by one. Even as the economy continues to expand, more and more borrowers are having difficulty remaining current on their debt. Which isn't surprising, given that median household income hasn't budged since 1999 (see Figure 1 on Page 4 of this Census report). What's more, in a natural reaction to reckless lending, mortgage companies and banks are now in money-hoarding mode and thus unable or unwilling to help Americans refinance existing debt. The Mortgage Bankers Association today came out with its "national delinquency survey," which has nothing to do with high-school kids sniffing glue. "The delinquency rate for mortgage loans on one-to-four-unit residential properties stood at 5.59 percent of all loans outstanding in the third quarter of 2007," up from 4.61 percent a year ago. This figure, which doesn't include loans in the process of foreclosure, is "the highest in the MBA survey since 1986." While the pain was concentrated in subprime (16.31 percent of subprime loans were delinquent in the third quarter), the seasonally adjusted delinquency rate for prime loans rose to 3.12 percent from 2.73 percent in the second quarter. As the volume and price of new home sales continues to fall (PDF), home builders are suffering, as well. The Wall Street Journal reported (subscription required) yesterday that delinquencies on loans extended to condominium developers have risen sharply in the past year. In the third quarter, 5.9 percent of such loans were delinquent, up from 4.1 percent in the second quarter, according to Foresight Analytics. The delinquency rate for builders putting up single-family homes rose from 3 percent in the second quarter to 4.3 percent in the third quarter. Other types of consumer debt, which have nothing to do with housing and nothing to do with subprime, are going bad, too. The Wall Street Journal reported today that "about 4.5% of auto loans made in 2006 to top-rated borrowers were at least 30 days delinquent as of the end of September, up from 2.9% the previous month, according to a Lehman Brothers survey of companies servicing these loans." In October, Fortune's Peter Gumble warned that a similar plague may soon afflict credit-card companies. In October, credit-card giant Capital One Financial reported that the delinquency rate on credit cards for the third quarter of 2007 was 4.46 percent, up from 3.53 percent in the third quarter of 2006. "Given current loan growth and delinquency trends," Capital One reported, it "expects the U.S. Card charge-off rate to be around 5.25 percent in the fourth quarter." The stock of First Marblehead, which has enjoyed explosive growth making private (i.e., not federally guaranteed) student loans, has been hammered in recent days because Moody's, the ratings agency, concluded that loans it had made "appear to be defaulting at a significantly higher rate compared to loans originated through school financial aid offices." The Wall Street Journal reported that "seventeen months after First Marblehead arranged one 2005 package of student loans, 2% had defaulted, according to the company's monthly reports to note holders. But last month, a comparable 2006 package—also 17 months after issue—had a default rate of 3.98%." And so it goes. The next arena likely to see a spike in delinquencies and then defaults? Corporate bonds. In September, ratings agency Standard & Poor's warned of a potential wave of defaults. Investors may have thought that Bush and Treasury Secretary Henry Paulson stuck their fingers in a hole in the dyke, thus forestalling disaster. But given the rising tide of bad debt across the economy, today's actions are more like throwing a sandbag into a rising Mississippi River. --------------- Daniel Gross is the Moneybox columnist for Slate and the business columnist for Newsweek. You can e-mail him at [EMAIL PROTECTED] He is the author of Pop! Why Bubbles Are Great for the Economy. Article URL: http://www.slate.com/id/2179389/ Copyright 2007 Washingtonpost.Newsweek Interactive Co. LLC -- Jim Devine / "The radios blare muzak and newzak, diseases are cured every day / the worst disease is to be unwanted, to be used up, and cast away." -- Peter Case ("Poor Old Tom").
