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BERNANKE:
Indeed, despite the Fed’s bare bones mention of “conditions” having “become tighter” in the credit markets, found in its Tuesday afternoon statement of no change in interest rates, the situation in the mortgage market continues to implode with the jumbo mortgage market now starting to feel the negative effects of the ongoing liquidity crisis. Elsewhere, one subprime mortgage lender, American Home Mortgage Investment, has filed for Chapter 11 bankruptcy protection. And there’s more, according to the Wall Street Journal, there is also more trouble ahead for the mortgage sector as "Aegis Mortgage Corp., Houston, notified mortgage brokers that it is unable to provide funds for loans already in the pipeline, a spokeswoman said. And Luminent Mortgage Capital Inc. of San Francisco said it faced calls for repayments from creditors and is suspending its dividend." So, here's where things stand, as we see them. There are two major problems in the mortgage market, a cash crunch, and a credit crunch, and they are related. When subprime borrowers stopped paying their mortgages, cash became scarce. Lower cash flows made it harder to get credit. Interest rates started to rise. And now fewer people can borrow money to pay off their loans. And the vicious cycle is repeating, rising in a deadly spiral that has now reached the mortgage lenders themselves, who can't get loans to pay off their own loans. And since many of these companies had relationships with each other, when the first one went down, it's likely just a matter of time before the dominoes start to fall. The big question then, is how long it will take for Morgan Stanley, Goldman Sachs, and Merrill Lynch to take a hit big enough for the Fed to come to their rescue. According to the Journal, citing comments by Doug Duncan, chief economist of the Mortgage Bankers Association, anyone who does business in the mortgage market right now has to be willing to hold on to the loan for a long period of time, or hope that the loan is of a high enough quality that it can be bought by Fannie Mae or Freddie Mac. Duncan told the Journal for any other kind of loan, "there is no market." So this seems to be a classic battle between Bernanke’s academia and the real world, and there are no winners, no matter how it turns out. If Bernanke lowers interest rates in the near future, the market will likely rally, but eventually some will wonder why he did it and the sellers will return, with the excuse being that if Bernanke bent to pressure the situation must be a lot worse than even people like Cramer were hinting at. Still others will likely say that Bernanke had no spine, and the Fed is in danger of losing its credibility in its fight against inflation. No matter what, the bottom of the pile borrowers won't get any help since they've already been foreclosed against. And the bankrupt, and possibly corrupt subprime lenders, might get a break that they may not have deserved, since their lax lending practices contributed to the current situation. What we're saying is that the current situation is complex, and is not likely to be resolved by one move to lower interest rates by the Federal Reserve. Once the Fed starts lowering rates, history shows, it won't do it just once. That means that for Bernanke to throw in the towel, there is going to have to be a whole lot more pain than we are currently seeing. Meanwhile, the market will do what markets always do, forecast the future. And right now that future seems more uncertain than it did six months ago.
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The
stock market has found support, near the 200 day moving averages for the
major indexes. This is a positive, but not necessarily the end of the road
for the current market’s story, as the potential for more problems in
the credit market is out there. In fact, a recent set of events is worth
noting, as we move forward into the Dog Days of August, a time when thin
volumes and vacant trading desks can make for highly volatile markets.
