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The Mortgage and Credit Crisis in the United States
Can the Fed Control It?
Many people think the Fed has “saved” Fannie and Freddie, and the FDIC will “save” all depositors from the effects of the mortgage and credit crisis in the United States. Most people hope the crisis is just another temporary interruption in the “normal” bull market, and a return to the status quo is just around the corner.
But an August 4 article in the New York Times says: “Homeowners with good credit are falling behind on their payments in growing numbers. ... Subprime was the tip of the iceberg. ... Prime will be far bigger in its impact.”
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Whoa. Postpone that return to normal; defaults are spreading from the riskiest class of loans into the “safe” mortgages. And, a few pesky fundamental problems remain:
- Home prices continue to fall.
- Economic growth is anemic at best.
- Huge losses hit General Motors.
- July unemployment hit a four-year high.
- Of the subprime loans made in 2005, 8.4% were delinquent in June 2008, while 2007 subprime loans are at 16.6% delinquent and rising steeply.
- Delinquencies in better-than-subprime loan categories, alt-A and prime, respectively quadrupled and doubled from a year earlier.
- Many prime and alt-A mortgages are scheduled to reset at levels that include principal payments, but many of these debtor-homeowners already face rapidly rising monthly payments. Some may see payments rise 50% even as their home values fall to below the mortgage amounts they owe.
Bailout or not, Freddie and Fannie still have big problems, as they own or guarantee nearly half of all mortgages. And did you notice that the bank run on IndyMac occurred after the FDIC takeover? That’s a sign that depositors doubt that the FDIC can insure against what looks increasingly like a historic credit deflation. August 1 saw the eighth U.S. bank failure this year, and one estimate says the FDIC is spending half its reserves to cover IndyMac alone. The FDIC can hand off some of the failed banks to other willing banks, but with record-low asset to deposit ratios and the continuing fall in home prices, how long will that willingness last? The FDIC’s “deep” pockets are growing shallower.
As the following quotes show, Robert Prechter's best-selling book Conquer the Crash alerted readers to this situation in plenty of time to steer clear:
Bank loans to home buyers are bad enough, but government-sponsored mortgage lenders – the Federal National Mortgage Corp. (Fannie Mae), the Federal Home Loan Mortgage Corp. (Freddie Mac) and the Federal Home Loan Bank – have extended $3 trillion worth of mortgage credit. Major financial institutions actually invest in huge packages of these mortgages, an investment that they and their clients (which may include you) will surely regret. ... When real estate prices begin to fall in a deflationary crash, lenders will experience a rising number of defaults on the mortgages they hold. My guess is that the Treasury will lose the $7 billion line of credit that it is required by law to extend to these quasi-government companies and even more if it attempts a bailout.
… Banks are going to own many, many homes, and their previous owners will be out in the street. ... It will be a disaster for the banks’ depositors, though, because there will be no one to buy the homes at mortgage-value prices. Depositors’ money will be stuck in lifeless property deals, marked down 50 percent, 90 percent or (as happened in the Great Depression) even more.
Speaking of lifeless property deals, perhaps you saw the recent headline in the Wall Street Journal, “After the Bubble, Ghost Towns Across America.” And maybe you spotted the July 23 Bloomberg headline, “Fannie Mae Unsold $5 Billion Homes Bring Peril to Shareholders.” The article told of a Fannie Mae-owned house in Flint Michigan that sold in 2005 for $110,000. In 2008, no buyer would touch it for $5000, a decline in value of at least 95%!
Conquer the Crash likewise gave early warning:
Credit expansion has supported real estate prices, but it is late in the game. ... People around the country are nearly unanimous in thinking that this is their last great opportunity to buy a house. Naturally, it is the opposite: It’s your last chance to sell.