From the NY Times:
Bear Stearns Companies, the investment bank, pledged up to $3.2 billion in loans yesterday to bail out one of its hedge funds that was collapsing because of bad bets on subprime mortgages.
It is the biggest rescue of a hedge fund since 1998 when more than a dozen lenders provided $3.6 billion to save Long-Term Capital Management.
The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes.
’03 was an extremely overheated market, we’re paying for it now. This should be the last of it, in late ’05 the investors pulled out, then the resale as customers try to off load the debt that way now the foreclosure wave is hitting. This is usually the last in the slump. Thankfully I’m still employed and attrition has meant we’ve not laid off. Praise the Lord for His provision.
On the bright side:
— Private investors bear the entire credit loss
— Orderly unwinding, with no government arm-twisting or other involvement
— The burned hand teaches best
the housing bubble will be yet another artifact of the Bush Regime that my children will be paying for
The blame sits more squarely on Alan Greenspan and his artificially cheap credit policies. Under Clinton, this manifested itself in the dot-com bubble. Under Bush, it’s housing.
Regular T19 readers will know I take a dim view of President Bush. But Bush’s role in the housing bubble is largely indirect. We have had a long economic expansion. Lulled by that expansion, lenders have become complacent about credit risk—the risk that borrowers will not repay their loans as agreed. Lenders have made more and more loans to weak borrowers. Lenders have also charged interest rates too low to cover the risk of default. The result is a flood of lending that has encouraged firms and individuals to take one more debt—debt that will become painful if interest rates rise or the economy falters. In the housing market, interest-only loans—with lower monthly payments designed to let homebuyers buy more house than they could otherwise afford—typify this complacency. So do business loans so cheap that firms borrow to do things they would not normally bother with.
Lower credit standards and unrealistically low interest rates may partly reflect the Fed’s monetary policy. But the Fed controls only short-term interest rates. Market forces set the sort of intermediate and long-term interest rates used to price mortgages.
Here’s a numerical example of how lenders are underpricing credit. Over the past two decades, Bonds rated BB+ (the high end of the junk-bond market) have paid interest at a rate 5.4 percentage points higher than U.S. Treasury securities. Thus if the Treasury had to pay 5% interest, BB+-rated lenders had to pay 10.4%. But BB+ lenders can now borrow at just 2.6 percentage points higher than the Treasury. Lenders are charging only half as much for the extra risk involved in lending to weak BB+ firms instead of to the Treasury.
This is madness. It results mostly because lenders act as though the good times will never end. They will. They always do. And (painful though it may be) it’s just as well that they do. By correcting financial and economic foolishness, economic downturns help keep the economy efficient.