Sub-Prime Lenders Melting Down as U.S. Mortgage Crisis Worsens

"U.S. mortgage crisis goes into meltdown", screams a headline in the London Telegraph.

"Panic has begun to sweep the sub-prime mortgage sector in the United States after the bankruptcy of 22 lenders over the past two months, setting off mass liquidation of housing loans packaged as securities.

"The rapid deterioration could not come at a worse time for British bank HSBC, which has set aside $10.5bn (£5.4bn) to cover bad loans in the [United States].

"The cost of insuring against default on these loans has rocketed in recent weeks, from 50 basis points over Libor to 1,200, raising fears that a credit crunch could spread to the rest of the property market."

The Telegraph went on to quote Peter Schiff, head of Euro Pacific Capital, who said that the mortgage industry is in an "unstoppable meltdown."

"'It's a self-perpetuating spiral: As sub-prime companies tighten lending they create even more defaults,' he said."

And from Ohio comes news of an "epidemic" of foreclosures.

So far, 20 companies in the sub-prime lending business have melted down. ResMAE, for example, turned into a blob last week. It filed for bankruptcy less than a year after management cut the ribbon on its new headquarters. The company was making so much money, and expecting to make so much more, that it built a lavish building, fit for a staff twice or thrice as large as the 497 employees it had.

Those were flush times for the lending business. There seemed to be no credit risk not worth taking. But what happened?

Our Law of Stupidity tells us that useful information declines by the square of the distance from the source. As the lending business became more and more "sophisticated", lenders and borrowers took leave of each other. Finally, they forgot they'd ever met. The Economist explains:

"Banks are traditionally supposed to know a bit about the borrowers on their books. But in many cases, their loans did not stay on their books long enough for them to care. Mortgages were written for a fee, sold to investment banks for a fee, then packaged and floated for another fee. At each link in the chain, the fees mattered more than the quality of the loans, which could always be passed on."

"For now, though, the Federal Reserve believes the damage can be contained," reports the Telegraph...so not to worry. "'I don't think there'll be a large impact on prime mortgages from the sub-prime market,' said [Fed] governor Susan Schmidt Bies."

But, she did admit that there was a "hidden" problem - sellers were pulling their property off the market, and leaving behind a lot of empty houses...and very soft property prices for a very long time.

Meanwhile, Nouriel Roubini (a professor of economics at NYU), thinks all this softness will push the whole nation into recession. As many as 600,000 jobs are being lost...as former real estate agents and ex-nail-bangers look for work. But what are they going to do?

Bill Bonner
for The Daily Reckoning Australia

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