`Strained' markets' red lights flashing

November 28, 2007|By JAY HANCOCK

So the mortgage crisis comes to this: Columbia's Fieldstone Mortgage enters bankruptcy proceedings, stiffing Wall Street's biggest names, and it's only a local story.

Mr. Bernanke, here's another indicator you're losing control. If a major subprime lender leaves Morgan Stanley, Household International, Bear Stearns and others holding a $100 million bag and the national news media ignore it, maybe the problem is a heck of a lot bigger than most of us dreamed.

Lower the short-term interest rates. Don't wait until the next Federal Reserve meeting in two weeks. Lower rates at least a half-percentage point. Then get ready to lower again.

For all of the damage it caused investors and homebuyers, Fieldstone's demise is a minor story because the overall mortgage mess is thousands of times bigger.

The problem is that it's not clear the Federal Reserve understands how much bigger and how much worse it's getting.

On Halloween the Fed judged that "the situation in a number of markets remained strained."

On Nov. 8 Fed Chairman Ben S. Bernanke told Congress that he expects "moderate, but positive, growth going forward."

On Nov. 16 Fed Governor Randall S. Kroszner said the most recent economic data releases "would not, by themselves" suggest that rates needed to be lower.

Every recession indicator known to man is flashing red, and the Fed says some markets are "strained?" Check out these data releases, Governor Kroszner.

Corporations that make up the Standard & Poor's 500 stock index saw profits fall 8.5 percent in the quarter ending in September, the fifth-worst performance since 1945. The last time something like this happened, reports Merrill Lynch economist David Rosenberg, was late 2000 -- right before the 2001 recession. The second to last time it happened was late 1989, right before the 1990-1991 recession.

In July 2006 short-term interest rates rose above long-term rates, creating the "inverted yield curve" that often portends recession a year and a half later. A recent decline in the ratio of employed people to the total population has a "100 percent track record" in predicting recessions, writes Rosenberg.

Yesterday's third-quarter Case-Shiller index showed U.S. housing prices dropped 4.5 percent from a year previously and 1.7 percent compared with the second quarter -- the worst showing in at least two decades.

Nationwide housing price declines have a long history as a recession harbinger. So does the kind of plunge we've seen in housing construction starts.

Consumer confidence hit its lowest point in two years this month and fell much further than analysts expected, the Conference Board said yesterday. Stocks have tanked. A dollar of Dow Jones industrial average profits (excluding one-time losses) sells for close to its lowest level in more than a decade.

And mortgage mayhem shows no sign of abating. Last week Freddie Mac, a government-sponsored lender, said it would write off $1.2 billion in bad mortgage debt. Freddie's stock has plunged 60 percent since the beginning of October.

This wasn't supposed to happen.

Freddie and cousin Fannie Mae were presumed to avoid the kind of subprime loans causing heartburn for investors in outfits such as Fieldstone. But Freddie, at least, wasn't careful enough.

Fieldstone, which specialized in subprime mortgages (many of them "liar loans," with no documentation of the borrower's income) is an object lesson in the danger of thinking mortgage pain is easily reversible and credit markets are merely "strained."

In February the company agreed to be bought by Credit-Based Asset Servicing and Securitization for $5.53 a share. In March, alarmed by the deterioration of subprime mortgage paper, C-BASS cut the price to $4. By late summer C-BASS said it might have to write off all of its Fieldstone investment. Then Fieldstone quit making loans at all. It has hit bottom now that it's in bankruptcy court, but plenty of other lenders have room to fall.

Meanwhile, they're trying to improve battered balance sheets. Reuters reported yesterday that Freddie will try to sell as much as $6 billion in preferred stock. Citigroup, which ejected CEO Charles Prince last month, is getting a $7.5 billion infusion from Abu Dhabi Investment Authority. Citi, Bank of America and JPMorgan are trying to raise $100 billion to buy troubled debt assets known as structured investment vehicles.

But even if lenders beef up capital ratios, that doesn't mean they'll lend. This is beginning to look like a widespread credit crunch -- not confined to mortgages -- and perhaps that's the surest recession sign of all. The volume of short-term corporate loans known as commercial paper is quickly shrinking. Banks are tightening standards for business loans.

And why not? If the Fed is going to sleepwalk into a recession, loan officers ought to be ultraconservative. A quick cut in short-term rates by Bernanke, however, would help change their minds and keep an economic setback from being inevitable.


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