http://www.mercurynews.com/valley/ci_6662566?nclick_check=1
By Chris O'Brien, Mark Schwanhausser and Sue McAllister
Mercury News-San Jose Mercury News
Article Launched:08/19/2007 01:35:38 AM PDT
As obscure financial crises go, the implosion of the subprime lending market last
year seemed easy enough for most folks to ignore.
Then, this summer, the stock market went bonkers. It became more difficult to get a mortgage.
And pundits started predicting that the economy was teetering on the brink of a full-scale meltdown
that would lead to higher unemployment and interest rates.
Goodbye, blissful ignorance. Hello, high anxiety.
Now that the average Joe and Jane are paying attention, they have two simple questions:
What happened? How bad is this going to be?
The answers lie in a convoluted tale that ricochets from the upper reaches of Wall Street to
the Realtors' shingle hanging on Main Street to the house that goes unsold on Your Street.
At its essence, though, the crisis illustrates how the global economy has created an interconnected
world where everyone's fate is increasingly tied together.
"Unfortunately, the economy is like a spider web," said Sung Won Sohn, president and chief executive
of Hanmi Bank in Los Angeles. "I wish we could say that high finance is in a box over here. And the
schoolteacher is in a box over there. But we're all linked together now, and everything we do affects each other."
The financial problems that burst into full view this year have been germinating for years. And there is no
single villain. Big financial calamities usually require lots of players making lots of decisions that look foolhardy
in retrospect.
Enough blame to go around
In this case, that includes lenders, investors, credit rating agencies, the Federal Reserve and, yes, lots and lots
of home buyers desperate to own a piece of the American Dream.
Here's what they were thinking.
Just after the dot-com bust in 2000, the stock markets plummeted. Over the next 18 months, the fallout dragged
the economy to a standstill.
Enter the Federal Reserve. As the economy sputtered, the Fed cut interest rates to 40-year record lows.
That cheap money spurred a housing boom that led to double-digit price increases from Sunnyvale to Miami.
The mortgage industry could barely hire enough people to keep up with a wave of borrowing that led to soaring profits.
But no boom lasts forever. And eventually, to keep this one going, the mortgage industry began pitching exotic
loans to borrowers with shaky finances. These loans - which in some cases may not have had credit ratings that
accurately reflected their risk - were funded by Wall Street investors hungry for higher returns.
By stretching underwriting standards - and, eventually, consumers' budgets -
these exotic loans enabled millions of new borrowers to buy homes.
And that easy money allowed people with meager means to buy homes they once could only dream about.
As long as all, or almost all, of these new homeowners made all their payments, as long as the rate of defaults
stayed low, as long as housing prices kept going up, everything would be fine.
The system was flawless. Until it wasn't.
In June 2004, the central bank reversed course and raised interest rates. The economy seemed to be humming along.
Companies were hiring. Stock prices were rising. Fed Chairman Alan Greenspan was now more worried about inflation.
It took some time, but mortgage rates crept higher. As adjustable-rate mortgages reset at higher rates, borrowers watched
their monthly mortgage payments balloon. An alarming number of borrowers - some of whom did not have enough equity in
their houses to be able to refinance or even sell - began to default.
Problems cascaded for the mortgage industry. Dozens of lenders went out of business. Home sales slowed. Housing prices
fell in some places, flattened in others.
Boom on Wall Street
Many things contributed to the frenzy on Wall Street. The job market - led by financial services and construction - grew strong.
Corporate profits rebounded robustly. And to boost their stock prices, companies spent billions of dollars to buy back their stock
in hopes of making their shares even more valuable.
They say a light bulb burns brightest just before it burns out. On July 19, the Dow Jones industrial average closed at
14,000.41, an all-time record high.
But beneath this triumphant march, the foundation had eroded.
In July, two Bear Stearns hedge funds collapsed after having made big bets on bonds related to risky mortgages.
Because hedge funds borrowed heavily to buy these bonds, falling bond prices quickly wiped out their collateral,
forcing them to come up with cash to satisfy their own lenders. Fast.
But how?
"They don't have the ability to say, `I will just hold on to it for a year and it will be better,' " said Meir Statman, a finance
professor at Santa Clara University. "A month is an eternity under those conditions."
With the markets suddenly leery of riskier mortgages, hedge funds found it difficult to value their bonds, let alone find buyers.
Rather than sell their mortgage-backed securities at fire-sale prices, they dumped stocks.
Goodbye, Dow 14,000.
In the past month, the Dow swooned, closing at 13,079.10 Friday. Along the way, it exhibited some wild mood swings.
The question is whether this will be a brief panic or the beginning of a deeper economic spiral. Where exactly will this stop?
"The markets are very fragile and unsettling. It's no fun to look at your stock portfolio and see it deteriorate," said Bill Kirsch,
managing director of Costella Kirsch in Menlo Park. "It doesn't feel like it will be a protracted event, but who knows?"
Some are betting the storm will abate soon. For example, Goldman Sachs lined up $3 billion last week to bail out one of its
hobbled hedge funds, calling it a good investment opportunity.
Others, however, are flashing back to deeper financial downturns, notably the 1998 global recession that was sparked by an
Asian currency meltdown, triggered a Russian financial crisis and endured the implosion of the massive Long Term Capital
Management hedge fund.
So far, those most directly affected are home buyers and lenders.
Mortgage resets coming
It's the housing market - already torpid in many parts of California and the nation - that is taking the biggest hits so far. In
fact,
many adjustable-rate mortgage rates have yet to reset, so the problems are likely to continue through 2008, according to First
American Real Estate Solutions in Santa Ana. Lenders have pulled back on mortgage loans to all but the safest borrowers and
clamped down on a range of riskier loans, which could slow things down even further.
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et chart fra en anden kild, apropos 'Morgage Resets'
[
http://piggington.com/files/images/136440158-O.preview.png ] ARM(Adjustable rate morgage) Reset timeline.
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Jan Rasmussen