Wednesday, January 13, 2010

Debt Market Collapse Could Worsen in 2010

The debt-securitization markets have been the source of roughly 60 percent of all credit in the United States in recent years. These markets finance corporate loans, home mortgages, student loans and more.

The private securities market — backed by home mortgages — has collapsed, from $744 billion at the peak of the housing boom in 2005, to $8 billion during the first half of 2009.

Many of these markets have been operating only because the government is propping them up. And now the Fed has put them on notice that it plans to withdraw its support this spring.

The hope is that private investors will return to the markets, which they abandoned during the financial crisis.

The government has since spent more than $1 trillion trying to restore the markets. So what happens when it finally extricates itself?

The Fed is virtually the only buyer for mortgage-backed securities, purchasing about 80 to 85 percent of the market.

As it stands, banks are not lending. And later this year, they face accounting rule changes and capital requirements that could further restrict their ability to make loans.

As a result, much will be revealed this spring, and throughout the year. The worst may lie ahead.

The Fed’s trillion-dollar intervention got it a mess of toxic mortgage securities. And it refuses to reveal exactly what it paid for them and from whom they bought them.

Removing these toxic mortgages from bank balance sheets recapitalized and reinvigorated both the banks and markets, allowing home-mortgage rates to remain low for both purchases and refinancing. Most of those mortgages are guaranteed by US taxpayers through the tanking mortgage giants Fannie Mae and Freddie Mac.

In addition, the Fed has maintained artificially low interest rates of nearly zero for an extended period. That, combined with the government's home buyer credits, may simply being re-inflating the housing bubble all over again.

When the government support finally ends, and when interest eventually go up (which they indeed will), home prices will fall even further as inventories increase.

The government expects foreclosures and losses in the housing sector to be so large that it recently removed the $400 billion cap on bailout money to Fannie and Freddie. That is an alarm signal by the Treasury about what lies ahead.

This year will lead to further turmoil in the mortgage and other debt markets. The government support will end, and there is no other entity that can sustain these markets. Credit has dried up, and will continue to do so.

Banks reduced lending in 2009 by about 18%, year-over-year. All indications point to a continuation of this trend in 2010.

Instead of lending, banks have pumped up the stock and bond markets with oodles of speculative cash fed to them by the government.

And as the nation has witnessed with great distress, what goes up eventually comes back down.

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