The housing market in the US is an important pillar in the global economy. The slow collapse of the mortgage market in the US is certainly not without dangers for economic growth worldwide. And yet there are increasing signs that things will not end well. Despite all the optimism of the banks and stock sellers, the mortgage crisis will also affect the rest of the financial world. Mortgage interest rates may drop.
In response to the internet bubble in 2000, the Federal Reserve, the FED, lowered interest rates several times. The intention was to dampen the aftershocks in the economy and stimulate the economy where possible. Thus a new monster was created, namely the housing bubble. Not only could Americans continue to borrow and buy, but the cheap money also provided a significant boost to the housing market. This market, where price increases of more than 10% have been achieved for years, has now become one of the most important pillars of the American economy and therefore also the world economy.
Subprime mortgage with a lot of risk
Not only was the housing market pumped up by low interest rates, but it even became possible to provide loans to risk groups that would otherwise never have received a reasonable mortgage. And I’m talking about people who would normally not be able to bear the burden. This market of risky mortgages, subprime loans, was boosted even further with so-called teaser loans. These are loans for which the interest rate is low at the beginning. After a certain period, sometimes a few months, you pay the full price.
While the interest rate was still low in the beginning, the short-term interest rate was even 1%, the interest rate is now rising and the long-term interest rate is more than 5%. As a result, taking out credit again is often no longer an option and more and more poor Americans are no longer able to pay the repayments and interest. Forced sales are the order of the day. Also among people who were in a higher segment than the subprime market. House prices are coming under further pressure in many locations in the US.
The proceeds from sales are often insufficient to pay the entire debt to the bank. Many mortgage banks are or are now getting into trouble. Well-known examples are New Century and Accredited Home Lenders. To give an idea: their combined value amounted to several tens of billions of dollars, but such a value can quickly evaporate. It is not without reason that ABN AMRO announced in early 2007 that it was selling its American mortgage business to Citigroup. Just in time. On the other hand, many hedge funds bought many risky shares with borrowed money to further boost their returns. Investment banks also bought many of them, rebundled them and sold them to third parties.
A number of negative factors loom here:
- The interest rate instrument is becoming increasingly blunt in the short term. Even if the FED decides to lower interest rates, banks in particular will become more cautious about lending money. The stimulating effect on the American economy will therefore diminish.
- The real income of Americans has hardly increased in recent years. They are savers, if not, so the only way to increase spending is through growing credit. Until recently, rising house prices seemed to provide excellent collateral, but now this option seems to be virtually disappearing.
- If mortgage providers in the US collapse further, this will have direct consequences for the American banking sector, the value of stock prices and the dollar. A nasty domino effect may be unfolding here.
- The government deficits are so large that stimulating the economy does not seem to be an option.
- Major changes in the housing market will have direct consequences for adjacent companies. By this I mean a company like Home Depot, where you can go if you want to renovate your house.
In short, without other stimulus measures, further growth slowdowns in the US will certainly occur if the mortgage market collapses.
Europe is currently experiencing an economic upturn, which means that this economy appears to be able to withstand a blow. One question is whether banks outside the US, including European banks, are not too involved in American concerns. Another question is how this will work out for hedge funds and the global stock exchanges. In the negative scenario, all this does not go well, resulting in all kinds of negative income and growth scenarios. After all, if people in the leading global economy of the US sneeze, the global economy catches a cold.
When the mortgage crisis in the US made headlines in March 2007, it immediately had consequences for the AEX, with ABN AMRO and ING as the biggest decliners. Dutch pension funds also have investments in the American mortgage market. In other words, if things go wrong worldwide, this will also apply to the Netherlands. The Dutch Bank stated in a quarterly report that it considers the effects and risks for our economy to be relatively limited, but states that if investors incorporate the risk assessment into prices, it is unlikely that the unrest will spread to the Dutch securitization market. Securitization is the process of packaging portfolios of mortgage loans into tradable bonds. We’ll see how things turn out. In any case, you have been warned, because as soon as risk aversion sets in, things are done.
American Home Mortgage Corp
On July 31, 2007, mortgage lender American Home Mortgage Corp on Wall Street also collapsed on news that it cannot meet higher margin calls from its lenders. This mortgage provider does not focus on the subprime sector, but on mortgages in the so-called Alt-A zone. That is, between prime and subprime. This could be the first big blow outside the subprime sector.
NIBC, you know, the investment bank that postponed its IPO this spring, also reported large losses on its mortgage packages on August 9, 2007, and does not rule out further losses. BNP Paribas is closing three mortgage funds today. NIBC no longer continues independently, but is being taken over by the Icelandic Bank Kaupthing. More and more banks in the US are getting into trouble. Bankruptcy is now also looming for Countrywide Financial, one of the largest mortgage providers in the United States, analyst Kenneth Bruce of investment bank Merrill Lynch reported on Wednesday, August 15, 2007.
It is striking that banks previously reported that they were hardly affected by the mortgage crisis in the US, while now suddenly (!) all kinds of banks are reporting collapse or losses. Some are still keeping their mouths shut because the losses are offset by gains on other investments, but how long before the truth comes out. Who’s next? See also the article US mortgage crisis visualized.