Mechanism for Credit Is Still Stuck

A year after financial tremors first shook Wall Street, a crucial artery of modern money management remains broken. And until that conduit is fixed or replaced, analysts say borrowers will see interest rates continue to rise even as availability worsens for home mortgages, student loans, auto loans and commercial mortgages.

The conduit, the market for securitization, through which mortgages and other debts are packaged and sold as securities, has become sclerotic and almost totally dependent on government support. The problems, intensified by bond investors who have grown leery of these instruments, have been a drag on the economy and have persisted despite the exercise of extraordinary regulatory powers by policy makers.

“The mortgage finance system in the United States has been badly damaged,” said Anthony Lembke, co-head of investments at MKP Capital Management, a hedge fund firm that is a big investor in mortgages. “There is definitely some reinvention that will need to occur, and that will include some explicit involvement by the government.”

CNBC.com

Bond investors first stopped buying private home mortgage deals, then shunned commercial mortgages. Now, they are becoming wary of credit card debts and auto loans. In the first half, private securitizations reached just $131 billion, down sharply from $1 trillion in the same period last year, according to data compiled by Thomson Reuters.

Some analysts say investors are acting like the “bond vigilantes” of the 1980s and early 1990s. Those traders drove a surge in interest rates because they feared inflation and a mounting federal budget deficit.

“The bond vigilantes took law and order in their own hands and pushed yields up, which would slow down the economy and bring down inflation,” said Edward E. Yardeni, an investment strategist who is credited with coining the term. “This time the bond credit vigilantes are refusing to go into the saloon and start drinking what Wall Street’s financial engineers are mixing.”

For their part, bond traders say that the weakening economy is making it harder for them to invest with confidence because even areas like auto loans, credit cards and commercial mortgages that once seemed secure now look vulnerable. They are also worried that demand for the securities they trade in will be weaker in the future as banks, brokerage firms and other investors are forced to sell.

Their reluctance to invest implies that credit, whether for businesses that want to expand or people who want to buy homes, will remain tight. That concern was underscored by the Federal Reserve’s most recent survey of loan officers, which on Monday showed that most domestic banks had tightened lending standards and that demand for loans had weakened in the second quarter.

The pullback is compounded by a continued rise in interest rates despite the Fed’s efforts to grease the wheels of finance by gradually slashing its benchmark rate to 2 percent, down from 5.25 percent last August. The average interest rate on a 30-year fixed mortgage climbed to 6.7 percent last week, from 5.89 percent in the spring.

“It appears that every time we peel away this onion, there is another layer,” said Curtis D. Ishii, the senior investment officer for fixed income at Calpers, the large California pension fund. He added that investors were starting to realize that the pain in the credit market would persist for some time.

One measure of that stress is found in falling home prices. “To the extent that home prices keep spiraling down, the need for capital keeps increasing,” said Alejandro H. Aguilar, a portfolio manager at American Century Investments, the mutual fund company. Investors will be able to better estimate the size of their losses once it becomes clear how far prices will fall and when they will hit bottom.

As they wait for the housing market to recover, many investors have continued to rush to safe havens like Treasuries and other debts with a government backing or a short payoff, a sign that investors remain unwilling to invest in mortgages, even though lending standards have improved from the go-go days of the housing boom.

Money market funds, the short-term cash alternatives, grew to $2.9 trillion in June, up from $2.1 trillion a year ago, according to Crane Data. Those funds, in turn, have more than tripled their holdings of Treasuries and other government debt while reducing the share of their portfolios invested in somewhat riskier corporate notes.

Patrick Ledford, chief investment officer at the Reserve, one of the nation’s largest operators of money market funds, said some institutional investors had moved assets into government funds from broader money market funds to avoid exposure to commercial paper, which are short-term debts.

CONTINUED : Prices fall despite safety net

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