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Credit Crunch May Hit Consumers Well Into 2008

The complex world of asset-backed securities may be a bit of a blur for the average investor. But the credit crunch that mushroomed from this market will buffet consumers well into 2008, analysts predict.

Tighter credit and tougher loan standards will persist, hurting those who are “marginal” borrowers. And while creditworthy consumers may dodge a direct hit, they will still be affected by the soft real estate market. The stakes are high because restrictive credit conditions often lead to recession.

“There will be an impact on consumers from all this for sure because lending standards have been tightening,” said Richard Berner, chief U.S. economist at Morgan Stanley. “The SIV crisis just sped up the process, making lenders that much more cautious.”

In a ripple effect from the sub-prime mortgage fiasco, Structured Investment Vehicles (SIVs), which are pools of higher-yielding debt, are facing a credit crunch. A portion of some SIV portfolios are invested in sub-prime securities whose values are hard to determine now that the market for these instruments has dried up. That has left the SIVs unable to tap the commercial paper market for short-term funds as investors have become more risk-averse.

SIVs, CDOs, CMOs and the other acronyms of the asset-backed business may befuddle consumers, but Wall Street’s problems could become Main Street’s headache. If credit aversion becomes more entrenched and the weak housing market persists, key sectors like consumer spending and jobs could suffer.

Bernanke's Warning

This was a scenario that Federal Reserve chairman Ben Bernanke’s alluded to at the end of August in a speech in Jackson Hole, Wyoming. He said, “…the tightening of credit conditions, if sustained, would increase the risk that the current weakness in housing could be deeper or more prolonged than previously expected, with possible adverse effects on consumer spending and the economy more generally.”

“This summer’s credit crisis seemed to have the most devastating effect on banks,” said

David Jones, president and chief executive officer of DMJ Advisors. “It was not just on the investment banks, which were in the midst of these markets, but the regular commercial banks. There was a total change in lending psychology.”

Now, experts note that the widening spreads which symptomized the summer’s panic have narrowed and interest rates have come down. But for those with less than great credit ratings, it’s a different story.

“The impact (of the crisis) is largely based on how good your credit is,” said Jay Brinkmann, financial economist at the Mortgage Bankers Association (MBA). “For the better credit borrower, it’s still easy to get loans and rates are coming down. But it’s clear that, for sub-prime borrowers, those (loan) volumes are way down.”

"Business As Usual"

“For the prime consumers, where the credit quality picture has not changed appreciably, it’s business as usual,” added Greg McBride, senior financial analyst at Bankrate.com. “Rates have followed the market lower and credit is available.”

Average variable credit card rates are 13.64 percent, down from about 14 percent in September and home equity lines of credit have come down about ½ percentage point, while auto loan rates have also declined modestly.

Rates for a fixed-rate Jumbo mortgage are about 1/8 to ¼ percentage point over conventional mortgage rates at 6-3/8 to 6-1/2 percent after being as much as 75 basis points over in August. The decline in these rates reflects the Fed’s recent interest rate cuts as well as the decline in risk premiums.

But those individuals at the lower end of the sub-prime spectrum find themselves effectively shut out of the mortgage market.

“The easy credit days are gone. You need a good credit history, proof of income and to bring something more to the closing table than just a pen,” McBride said, referring to the down payment.

Economic Impact

Analysts say the jury is still out on whether the housing woes will be severe enough to bring down the rest of the economy. Some hope that the credit crisis can be contained, barring further economic shocks.

“The problem is that there are too many houses on the market at the moment, given the number of potential buyers. And with credit being tightened, there are even fewer buyers, leaving more inventory,” said Brinkmann at MBA. “But the heart of the market, (the creditworthy borrower), has not seen any real deterioration.”

Economists noted that the Fed will need to move further to forestall a worse outcome,

with many seeing economic weakness persisting through the first half of next year.

“Credit crunches almost always lead to recession if the Fed’s easing doesn’t ameliorate things fast enough,” said Ed Yardeni, president of Yardeni Research. “There’s a bit of a horse race going on now, but I believe the Fed will succeed in stabilizing the financial system.”

Jones of DMJ expects that fourth-quarter GDP growth will drop to about 1.5 percent, from an expected 3.0 percent in the third, and to 1.3 percent in the first quarter of 2008.

“I see a very dismal Christmas and fourth quarter because we have a perfect storm building,” said Jones. “Not only the tightening in credit, but higher oil prices and declining home prices. We will be lucky to avoid recession.”