| Credit Problems Ahead |
| By Credit Federal |
Published
12/27/2007
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Financial News
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Credit Problems May Continue
Because credit problems associated with the housing and mortgage crisis have escalated, the economy is threatened with a recession. Even people who didn't think the crises would affect them may very well also suffer the failout.
Warnings Ignored - Although there were signs of trouble; escalating late payments, threats of not being able to meet payments when variable rates were adjusted, a declining housing market while home building continued, lenders, real estate agents and home builders continued business as usual as though blind to the increasing high risks.
Even Federal Reserve Chairman Ben Bernanke thought that the increasing default rates among subprime borrowers with shaky credit were "likely to be contained."
That statement boosted Wall Street's confidence, and sent the major stock indexes soaring to new highs. Such gains were also fueled by the record-setting pace of debt-laden buyouts, which drove investors to scoop up shares of companies they wagered would be the next to be taken over.
Every now and then, naysayers would try to spoil the fun, but most didn't heed their warnings. Bank of America CEO Ken Lewis said in May that the only way to wake up investors to the risks of highly leveraged buyouts would be by a deal going bad. "We are close to a time when we will look back and say we did some stupid things," he said.
But cheap debt made dealmaking too attractive to let the party stop, and everyone seemed anxious to take part, as exemplified by the attention given to Blackstone Group's initial public offering in June.
Right before its IPO, Blackstone founder Stephen Schwarzman told The Wall Street Journal about how he operates his buyout firm. "I want war - not a series of skirmishes," Schwarzman said. "I always think about what will kill off the other bidder."
It's a philosophy he will have to remember during the next dealmaking boom. Weeks after the much-hyped Blackstone IPO, credit conditions began to deteriorate quickly, causing a sudden halt in takeovers. Blackstone's shares have largely plunged since, losing a third of their value since the $31-a-share IPO.
The implosion in subprime mortgages forced a market-wide reassessment of risky debt. Once free-flowing liquidity dried up as lenders everywhere raised interest rates and investors demanded better protection against risk.
That put banks and other financial institutions on the spot. Not only were they unable to unload the debt to finance most buyouts, but their complex debt securities tied to subprime mortgage assets also plunged in value. Around $100 billion in subprime exposure has been written off at banks and brokers worldwide this year.
Such losses cost two big-name CEOs their jobs. Citigroup's Chunk Prince and Merrill Lynch's Stan O'Neal were blamed for letting their firms take on risk that clearly outweighed the reward.
Prince knew that trouble could come - but was slow to see it happen. "When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing," he told the Financial Times on July 10. Days later, broad credit woes would begin. By early November, he lost his job.
Those CEOs are now gone, but others have managed to stay - to the wonderment of many analysts and investors. Topping that list is Countrywide Financial Corp.'s Angelo Mozilo, who has become the poster-child for the housing bust.
The CEO of the nation's biggest mortgage lender spent the first part of the year downplaying the subprime crisis and saying the company's financial condition "remains strong." Then he tried to use the spin that "nobody saw this coming" as the industry and his company melted down. Countrywide lost $1.2 billion in the third quarter, its first quarterly loss in its 25-year history.
Mozilo can salve his wounds with the $167 million, by Thomson Financial's count, that he got from the sale of Countrywide shares this year. The lender's investors aren't so lucky: Their shares are trading around $10 each, a quarter of what they were at the start of the year.
At other battered companies, too, including Morgan Stanley, Bear Stearns and Washington Mutual, executives' jobs are hanging by a thread.
The coming months will tell if they should go. The outlook for the economy isn't in their favor. An already terrible situation looks to be getting worse, with many economists - including former Fed Chairman Alan Greenspan - raising the likelihood of an upcoming recession.
Should that happen, it would hit as local governments and school districts in places like Florida and Montana already are feeling the pinch from debt investments gone bad. Other cities, universities and more are facing possible tax increases because future municipal bond offerings are likely to carry higher interest rates as a result of major bond insurers getting downgraded.
That shows just how contagious the housing and mortgage mess turned out to be. Bigger by far than almost everyone thought.
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