Credit Crisis: Is the Worst Behind Us?
co-written with RGE Monitor’s Lead Analysts
Is the credit crisis over? Or are we just in the eye of the storm? There seems to be a growing sentiment among analysts that the worst of the credit crunch has passed and financial markets are slowly recovering. Unfortunately the troubles in the real estate finance sector are far from over. In addition, the spillover to other parts of the credit markets – auto loans, student loans and credit cards – and as a consequence to the engine of the U.S. economy – the U.S. consumer – could be just at the beginning. The labor market can be considered effectively in a recession and personal consumption is consistently reducing its contribution to GDP growth. It might, therefore, be too early to declare the end of financial turmoil and of its effects on the real economy. And a negative feedback loop from a contracting real economy to worsening financial markets cannot be ruled out. Check out: “Credit Crisis: Is the Worst Behind Us?”
Hopes that the worst – in terms of subprime-writedowns – is behind us are being curbed by new estimates published last week by FitchRatings and the OECD. Both agencies base their calculations not only on illiquid and volatile ABX prices but on proper default models. Starting from the $165bn subprime losses disclosed today, the new estimates range from $400-550bn at Fitch and from $350-420bn at the OECD.
The notion that all is not clear prevails also in the money markets. Interbank lending spreads refuse to recede significantly despite extended liquidity facilities and sharply lower CDS spreads. NY Fed Vice President William Dudley points to banks’ balance sheet constraints with regard to re-intermediation of off-balance sheet items and the need to deleverage – rather than mostly counterparty risk – as the cause of the persistent stress in money markets. Both factors are here to stay in the foreseeable future. See: “Interbank Stress Persists Despite Easing Counterparty Risk in CDS”
The extension of lending facilities against constantly deteriorating mortgage collateral raises questions about the credit quality of central banks’ reserve assets. These concerns are justified as taxpayers will be left footing the bill should a credit loss materialize. Follow the discussion in: “Lending Against Shaky Structured Collateral: Central Banks and Credit Risk”
Policy makers are looking ahead to try to prevent another financial crisis. Many previous crises were marked by excessive leverage, speculation, procyclicality of credit and regulatory myopia. After every crisis, academics, regulators and policy makers scurry to figure out ways to prevent its re-occurrence and beef up regulation only to find their efforts blindsided by a new breed of crisis or rolled back by deregulation after years of stability-inducing complacency. Read: “How Can Policymakers Prevent Another Financial Crisis?”
With surging foreclosures, the White House has started yielding to the Senate Plan which attempts to put a floor on home prices – whose fall seems to be accelerating. The $500mn Plan would provide FHA guarantees for Fannie and Freddie to refinance $300bn low fixed rate loans for homeowners with negative home equity with lenders taking a cut on the principal. Negotiation between the White House and Senate will likely continue over financing and eligibility criteria. Some analysts worry that the plan might have the adverse effect of lower home prices/higher interest costs in the future, thus raising the risk of default. Others argue that this backstopping of the mortgage market can prevent a destabilizing tsunami of foreclosures. Check out: “White House and U.S. Senate Move Close to Legislation on the Housing Crisis”
Finally, the monetary firefighters are injecting liquidity and devising heterodox measures to keep financial institutions in business. Yet, in the future, another asset bubble is likely to build and crash somewhere outside the reach of regulation. This has stirred up the debate on whether central banks should target asset prices – can we foresee bubbles and prevent or pop them or is mitigation after the bust the best that can be done?
Also in the Monitor:
2 Responses to “Credit Crisis: Is the Worst Behind Us?”
3193604 beers on the wall.
I found this really good post the other day….