Meme of the day: Credit crunch!

There’s a great debate raging over at Morgan Stanley’s Global Economic Forum

today. Richard

Berner kicks it off:

The long-awaited meltdown in subprime mortgage lending is now underway, and

it likely has further to go. Fears are rising that this so-far idiosyncratic

credit bust will morph into a broader, systemic credit crunch as foreclosures

rise, lenders grow cautious, and Congressional efforts to rein in predatory

lending further choke off supply. A credit crunch occurs when lenders deny

even creditworthy borrowers access to borrowing. What are the risks of such

a scenario?

Worries about a wider credit crunch are dramatically overblown,

in my view. Spreads may widen further and the supply of subprime credit likely

will tighten. But the balance sheets of most lenders are strong, investors

are differentiating among rungs of the mortgage credit ladder, and a limited

incipient spillover into prime loans and other asset classes signals that

a credit crunch is remote.

Stephen Roach, on the other hand, is much less sanguine.

Whether it’s the bursting of the US housing bubble, carnage in sub-prime

mortgage lending, or a slowing of Chinese investment, these events are quickly

labeled as “idiosyncratic” — unique one-off disturbances that

are perceived to pose little or no threat to the larger whole. The longer

a seemingly resilient world withstands such blows, the deeper the conviction

that spillover risk has all but been banished from the scene. Therein

lie the perils of a dangerous complacency

Like virtually every other credit event that has unfolded in the past several

years — from auto downgrades to the implosion of Amaranth — our credit strategists

have been quick to label the sub-prime mortgage problem as idiosyncratic.

While spreads have blown out in this relatively small segment of the US mortgage

market — with sub-prime loans about 11% of total securitized home loans —

spreads for higher rated mortgage credits have been largely unaffected. Again,

I don’t dispute the facts as they have unfolded so far. My problem comes

in extrapolating this resilience into the future. With resets on floating

rate mortgages likely to put debt service obligations on a rising path for

already overly-indebted US homeowners, the case for increased default rates

and collateral damage on prime mortgage lenders looks increasingly worrisome.

Indeed, as the recent warning from HSBC just indicated, it’s not just

the small specialized lenders that are now being hit. Spillover effects are

quickly moving up the quality scale on the financial side of the post-housing-bubble

shakeout story, and their potential for impacts on the broader economy can

hardly be dismissed out of hand.

No prizes for guessing where Russ

Winter comes down in this debate:

We now know for a fact that the subprime mortgage market is in increasing

disarray. Although not publicized in the mainstream media (MSM) the

cracks are spreading to the midprime arena as well. I am convinced that the

next wave of stories will emerge from the Alt A market. I also strongly

suspect that any market break will come like a thief in the night…

I’m with Berner on this one. As we’ve seen at HSBC, if there are losses in

the subprime mortgage sector, they’re more than outweighed by profts elsewhere

in the subprime sector, let alone profits elsewhere in the mortgage sector.

So long as the lending you’re doing remains profitable, there’s little point

in cutting back on it just because old unprofitable lending turns out to have

been a bad idea. Subprime mortgage underwriting standards have already

tightened up considerably, and I’ll happily bet anybody that the 2007 vintage

of subprime MBSs will perform very well. Yes, there was a period of irrational

exuberance among subprime lenders. But it’s over now, and the broader systemic

risks have passed as well.

This entry was posted in Econoblog. Bookmark the permalink.