Your Latest Credit Crisis Road Map
Stock-Markets / Credit Crisis 2008 May 09, 2008 - 09:55 AMBy: Money_and_Markets
Mike Larson writes: New developments in the credit and bond markets are happening fast and furiously. This week, I'm going to give you my latest take on the most significant news unfolding.
I'll tell you what I'm seeing, why it matters, and what it means to you as an investor. Here goes ...
The latest Federal Reserve survey shows credit is NOT loosening.
I pay a lot of attention to a particular study the Federal Reserve conducts every quarter. It's called the "Senior Loan Officer Opinion Survey on Bank Lending Practices," and it tracks whether credit demand is rising or falling, and whether lenders are tightening or loosening their lending standards.
The Fed figures are reported in terms of "net tightening/loosening." Specifically, the Fed adds up the percentage of banks that either "tightened considerably" or "tightened somewhat" in a given loan category and nets that out against the percentage of banks that "eased somewhat" or "eased considerably." We just got the results for the second quarter of this year, and they weren't pretty:
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| After suffering massive losses, Citibank and its rivals are aggressively tightening their lending standards. |
A net 55.4% of lenders tightened standards on commercial and industrial (C&I) loans to large- and mid-sized customers in the second quarter of this year. That's a big surge from 32.2% in the prior quarter and -3.7% a year earlier (meaning that a year earlier, banks were generally easing standards on these kinds of loans).
In the commercial real estate (CRE) arena, a net 78.6% of lenders tightened standards. That's the second-highest reading on record, behind the first quarter of this year.
The residential mortgage market is in even worse shape. The Fed has only been reporting separate net tightening figures for prime mortgages and other types of home loans since the second quarter of 2007. We just learned that 77.5% of lenders are tightening standards in subprime — the highest percentage ever.
More importantly, a net 62.3% of lenders surveyed were tightening standards on PRIME mortgages. That's up from 52.9% a quarter earlier and the highest the Fed has ever found. In the 18 years the Fed has been tracking home mortgage standards, it had never previously found a reading over 32.7%. That was back in the first quarter of 1991.
Last but not least, the percentage of lenders tightening standards on credit card loans jumped to 32.4% from 9.7% in the first quarter of 2008. That's the highest since 1997. The tightening percentage for other consumer loans is now running at 44.4%, the highest since the Fed began collecting data on that category of loans in 1996.
All told, these latest Fed figures tell the same tale: Lenders are generally pulling in their horns after several years of crazy credit conditions. The tightening trend is most aggressive in the mortgage arena. But banks are also getting stingier with consumer, corporate, and commercial real estate loans.
It's worth noting that measures of consumer credit demand have improved slightly. So it's not that consumers don't WANT to borrow — it's that many can't under today's tighter guidelines. That brings me to ...
Surging credit card borrowing — and what it means ...
We just got some startling statistics: In the month of March, consumer credit borrowings — for auto loans, credit cards, and other non-real estate loans — surged by $15.3 billion. That was the biggest rise since November and much more than the $6 billion economists were expecting. In fact, consumers took out $34 billion in these loans during the first quarter, the most since 2001.
It's generally considered healthy when consumer borrowing rises. It shows that consumers are ready and willing to borrow and spend, promoting growth. But that's only if the economy is strong and consumer balance sheets are in good shape. And you probably don't need me to tell you that is most definitely NOT the case right now.
Instead, I think consumer borrowing is surging for two UNHEALTHY reasons ...
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| As gasoline prices soar to record levels with no relief in sight, consumer's initial sticker shock has turned into financial pain at the pump. |
First, falling home values and tighter mortgage lending standards have all but shut down the "housing ATM." Borrowers had grown accustomed to taking out home equity loans and lines of credit, then using that money to pay for vacations, boats, RVs, and more. They can't do that any longer — either because their equity has evaporated or because banks no longer want to lend against what remains out of fear home prices will fall further — leaving them holding the bag.
Second, surging food and energy prices have left consumers with few options. Their incomes generally aren't keeping pace with inflation, so they're being forced to use credit cards to finance even everyday purchases.
In other words, this surge in consumer credit isn't a sign of strength. It's a sign of weakness.
Meanwhile, there's ...
No rest for the weary in today's housing market!
We get a fresh batch of housing market news every month. The latest figures were on "pending" home sales — contracts signed to buy existing homes. The National Association of Realtors said:
Pendings dropped another 1% in March. Moreover, February's reading was revised lower — to minus 2.8% from the previously reported 1.9% decline.
Regionally, pending sales fell in 3 out of 4 regions — the Midwest (-10.4%), the South (-0.1%), and the West (-1.4%). Sales rose 12.5% in the Northeast.
The pending sales index — at 83 in March — set a fresh record low. It's down about 20% from a year ago and 35% from its peak in April 2005.
The bottom line: The string of unimpressive housing numbers continues. There's a real risk that many of these pending sales won't turn into closed transactions, too, given the tightening we've seen in the mortgage lending market.
If there's a bright spot out there, it's that the supply of homes for sale does appear to be declining in some markets. I attribute that to a combination of falling construction activity, fire sales of spec homes by home builders, and aggressive pricing by other motivated sellers, including banks holding foreclosed properties.
But this also puts pressure on everyday folks who are trying to sell. Every fire sale lowers the comparable sales data that real estate agents, appraisers, and banks use to figure out the value of other homes in the same area. That means traditional sellers have to cut prices to compete with the motivated ones, dragging overall values down.
Finally ...
The bond market is on the brink!
As you know, I'm intently focused on what is happening in the Treasury bond market. It looks like bonds are right on the brink of a significant technical breakdown. An uptrend in long bond futures prices that dates back all the way to last June recently gave way, and now, bonds are testing their 200-day moving average.
If this area of support fails, I think we could see a quick, nasty fall of as much as five points. Yields on the benchmark 10-year Treasury Notes could spike sharply — from around 3.9% today to the 4.5% area. That, in turn, would push up long-term financing costs, including fixed mortgage rates.
Fundamentally, the reasons behind this sell-off are really quite simple: Treasuries are about as overvalued an asset as you'll ever find — in ANY market! Yields on most forms of U.S. debt — and the federal funds rate itself — are below the rate of inflation.
That means REAL (inflation-adjusted) interest rates are negative!
This can't persist. Investors won't put up with it. They're LOSING money after inflation, even factoring in the coupon yield on their bonds. Either inflation is going to plunge, or bond yields are going to soar.
I don't know about you, but I see no sign whatsoever that inflation pressures are ebbing. So I'm betting the problem will resolve itself with bond prices falling and bond yields jumping.
Even the "see no inflation, hear no inflation" Federal Reserve is finally paying attention. Kansas City Fed President Thomas Hoenig stepped up to the microphone this week in Denver, warning ...
"There is significant risk that higher inflation will become embedded in the economy and require significant monetary policy tightening to reduce it."
He added that he's seeing an "inflation psychology to an extent that I have not seen since the 1970s and early 1980s."
That's some tough talk from a Fed that has been sitting idly by and ignoring the burgeoning inflation problem. It validates the move higher in bond yields, and suggests even bigger increases are coming down the pike.
What does this mean for you?
Well, I'd continue to avoid long-term bonds. I think they're a losing investment in this inflationary environment. I'm not a big fan of most vulnerable U.S. financials either, though there are always a few exceptions. Many overseas banks and lenders look like better bets.
If you're shopping for a mortgage, I'd strongly consider locking in a fixed rate now rather than waiting. I believe 30-year rates are headed higher.
Meanwhile, if you're planning to finance the purchase of a new car or a home improvement project, make sure you nail down your financing early in the process. You don't want to hire your plumber, electrician, screen guy, and so on, put the deposits on your credit card, then find out that your bank won't give you a home equity loan to finish the job.
As always, I'll keep my nose to the ground, and my eyes and ears open to the latest developments in the credit markets — and let you know all about 'em right here in Money and Markets .
Until next time,
Mike
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