How the US Banking Crisis Will Strangle the Mortgage Market
Jul 15th, 2008 | By John Stepek | Category: Real Estate InvestmentsThe reality is that regardless of how much money the US government pumps into Freddie and Fannie, the US financial system is in big trouble – and the sooner they face up to it, the better…
Why Mervyn King deserves a bigger pay rise
US mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) have been deemed too big to fail.
But investors are only too aware that not every bank or lender is in the same lucky position. The Federal Reserve didn’t step in to save IndyMac, a Californian lender which was taken over by the Federal Deposit Insurance Corporation (roughly the equivalent of our Financial Services Compensation Scheme) at the end of last week.
That’s focused attention on which regional bank could be next to fail, which in turn sent US banking stocks tumbling yesterday. But don’t let the name ‘regional banks’ fool you. We’re talking about some of the biggest banks in the US.
The reality is that regardless of how much money the US government pumps into Freddie and Fannie, the US financial system is in big trouble – and the sooner they face up to it, the better…
Not all banks are as lucky as Fannie Mae and Freddie Mac
The US government has shown that Fannie Mae and Freddie Mac are definitely too big to fail. They’ll do whatever they can to prop up the mechanisms that keep the US mortgage market going.
However, it’s every man for themselves when it comes to the rest of the banking system. Californian lender IndyMac (IMB), which collapsed on Friday, was one of the biggest banks to ever go under in US history. It could, says the FT, end up being the most costly to clear up as well. The FDIC might have to shell out from $4bn to $8bn of the $53bn it has set aside to compensate depositors. That’s a lot of money to be shelling out at the start of a crisis which is very likely to claim more banks.
The bank went under after depositors pulled out $1.3bn “in a matter of days”, according to regulators. The timing was partly down to one Senator Charles Schumer warning the FDIC that IndyMac was in trouble – that triggered the run. But the real problem was that IndyMac was heavily into Alt-A lending. Alt-A are basically self-certification mortgages. They’re not deemed sub-prime, but because you’re relying on the honesty of the applicant, they might as well be. As bad debts soared and house prices plunged, it was only a matter of time before IndyMac ran into trouble.
The good news is that the US is better set up for banking collapses than we are. After all, more than 1,000 institutions failed during the Savings & Loan crisis of the late 1980s and 1990s. According to the FT there are nowhere near that many banks in that kind of trouble just now – but then, it’s early days yet.
What all this means for the US housing market
The real problem is the impact that all of this is going to have on the US housing market. As the FT says, “With US banks licking their wounds… [Fannie and Freddie] are critical providers of new credit.” But it’s hard to see how they can do this, given that the main aim for these two should now be to improve the state of their balance sheets, “reducing the US government’s role in supporting the housing market.” The way to heal their balance sheets is to cut back on taking on more liabilities, not keep providing cash for fresh mortgages.
In the meantime, as Lex puts it, “housing markets will suffocate for lack of the oxygen that is credit”, while “financial assets will continue to sag for want of any real appetite for risk.”
Source: How the US Banking Crisis Will Strangle the Mortgage Market
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John Stepek is Deputy Editor of the UK-based financial weekly MoneyWeek. He is also the editor of daily investment email Money Morning UK. John graduated from Strathclyde University in 1996. He has worked for a number of financial magazines and newsletters including Families in Business, Shares Magazine and The Sunday Times.