RISMEDIA, August 10, 2007–”Financial markets endured quite a roller coaster ride in recent weeks, as the gap between perceived and actual credit risks converged. The ongoing meltdown in the risky end of the mortgage market tested the limits of existing credit risk models, which are better suited to estimate the risks of traditional credit portfolios than the more exotic products attached to subprime and Alt-A mortgages, which require less documentation,” says Diane Swonk, chief economist of Mesirow Financial, in her August issue of Themes on the Economy available at www.mesirowfinancial.com/pdfs/newsletters/themes/themes_0807.pdf.
“The repricing of subprime ARMs (adjustable-rate mortgages) were especially problematic as it stressed the balance sheets of previously solvent borrowers. Defaults surged, foreclosures skyrocketed and the value of those inventories plummeted, as lenders were forced to auction off hundreds of homes at a time to get them out of their mortgage portfolios,” notes Swonk.
In her August newsletter, Swonk takes a closer look at the factors that contributed to the recent flurry of repricing in credit markets, the extent to which it is likely to result in tighter credit conditions, and the implications of those shifts for the housing market and consumer, which include:
– Several major banks announced larger-than-expected write-offs in the
subprime and Alt-A mortgage markets, which underscored the need to
raise risk premiums for riskier, less-documented loans.
– A record number of leveraged buy outs (LBOs) went to market looking for
funding, which temporarily overwhelmed market participants.
– A tightening of credit conditions, especially for potential home buyers
who must now face more stringent lending standards and slightly higher
rates. Even wealthy borrowers are now expected to go the extra mile to
document their incomes. The squeeze on low-income and speculative home
buyers, however, has clearly been more pronounced than anywhere else in
– The recent repricing of credit conditions in the housing market will
likely exacerbate up-front losses by constraining sales and starts in
the near term.
– Fears of an all-out credit crunch, however, are clearly overblown.
Credit is still readily available to credit-worthy borrowers.
Moreover, the Fed could step in and ease rates if worst-case scenarios
are realized and a credit crunch does materialize.
– There are also concerns that conditions for other types of consumer
credit, such as credit cards and auto loans, will tighten. Credit
quality in the credit card market, however, is significantly better
than in the mortgage market, with charge-offs hovering near a decade
– Employment and income growth remain solid. This will not only keep
qualified buyers in the market, but should also raise the credit scores
of a whole new set of home buyers who were left behind earlier in the
“On net, consumer spending is expected to slow, but not collapse, in response to the correction in housing. This, coupled with ongoing gains in exports, business investment and inventories, is expected to hold GDP growth close to trend for the balance of 2007 and into 2008. The U.S. economy is expected to emerge from the recent hail storm in financial markets relatively unscathed and, once again, prove its remarkable resilience in the face of adversity,” concluded Swonk.
The August issue of Themes on the Economy as well as archived issues can be found at www.mesirowfinancial.com/. For more information about Mesirow Financial, visit its Web site at www.mesirowfinancial.com/.
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