Yesterday's New York Times reported that the funnel of investor money into United States consumer loans and related products is very sticky, if not entirely stuck.
In "Mechanism for Credit is Still Stuck," Vikas Bajaj reports that:
"A year after financial tremors first shook Wall Street, a crucial artery of modern money management remains broken. And until that conduit is fixed or replaced, analysts say borrowers will see interest rates continue to rise even as availability worsens for home mortgages, student loans, auto loans and commercial mortgages."
What Mr. Bajaj is talking about is the process of securitization -- where bonds promising yield to investors are created with the backing of specific assets. So, for example, a mortgage security is created which generates yield to investors and which is presumably very safe because, well, "U.S. homeowners rarely default on their mortgages." These products are so safe, in fact, that up until a year or so ago, the three major ratings agencies were rating some of the mortgage securities AA and AAA -- comparable to U.S. government debt.
The problem, of course, is that U.S. homeowners have defaulted on their mortgages -- in fact, in record numbers. As I have written in other places and media, I believe the causes of these defaults are many but primarily due to a rigged system that put people into an environment and mindset to take on much too much debt. But, the reasons are not what is relevant for purposes of this present posting.
What is relevant is that the United States financial system -- particularly the lenders and investment banks -- sold the world's investors mortgage securities which were founded on faulty assumptions -- that a) U.S. homeowners will never default, and b) that U.S. housing prices always go up. In addition, the financial geniuses in the investment banks created products that were so complex -- e.g. derivatives which depended on yield from other securities -- that few really understood what they were selling or what they were buying. All this in the name of profit, of course, for when the housing market was humming, those securitizing mortgages made billions.
But now the chickens have come home to roost. Lots of investors who thought they were buying safe products are stuck with empty promises and poor returns. And, in some cases, these are the same potential candidates to buy securities backed by other U.S. loan products -- credit cards, student loans, auto loans. Is it any surprise that these investors are now wary of the system?
Here is how Edward E. Yardeni describes the situation:
"This time the (investors) are refusing to go into the saloon and start drinking what Wall Street's financial engineers are mixing."
If the world loses confidence in the U.S. financial system, we all have a headache. As is happening today, loans will be both more difficult and more expensive to obtain.
Author Kevin Phillips in his book, Bad Money (Perseus, 2008), refers to the potential trillion dollar loss which banks and investment banks may incur as a result of the housing meltdown. That is bad of course but Phillips makes a more important point:
"If the world loses confidence in the American markets, the long-term costs will be greater than a one-time trillion dollar balance sheet write down."