How a mortgage mess led to 'confidence' crisis

NEW YORK -- So this is what they mean by a credit crunch.

For months, there has been lots of talk about what a global debt squeeze could look like, but plenty of market commentators and economists said we weren't there yet. Don't worry, they said, you'll know when you see it.

Then came August.

As liquidity has severely dried up credit markets, the trouble has flowed over to stocks, with investors getting jittery over fears that a full-blown crisis is here.

Clearly, this isn't just about risky borrowers defaulting on their home loans. That is where all this trouble started, but it won't be where it ends.

Things have gotten much more complicated for the financial world now that lenders everywhere are tightening their borrowing standards. Loans are harder to get, no matter if you are a creditworthy individual buying a house or a company looking to finance a share repurchase plan.

The mortgage business, of course, is where the trouble is most obvious. A survey released Monday by the Federal Reserve showed more than 56 percent of the nation's banks have tightened lending standards on subprime mortgages -- those home loans given to buyers without the best credit.

More alarming in the Fed survey was that some 14.3 percent of loan officers have also tightened their lending standards "somewhat" to those with strong credit histories.

This shows up in the skyrocketing rates on prime jumbo mortgages, which have surged to five-year highs due to the increased worries about the risk of default among those borrowers taking out loans topping $417,000.

The average jumbo 30-year fixed rate jumped to 7.35 percent last week, up sharply from around 6.6 percent this spring, according to Bankrate.com.

And that has come without any increase in the Fed's key overnight lending rate, which has stood at 5.25 percent since last August. Generally, mortgage rates rise and fall along with the Fed's rate moves.

This is battering mortgage companies, which not too long ago were saying that all would be well. Now, they are warning that things will get worse before they get better.

Countrywide Financial Corp., for instance, said on Aug. 2 that its financial condition "remains strong," despite the weakening credit conditions. But by Aug. 9, the Calabasas, Calif.-based mortgage lender was singing a much different tune when it said that its profits in the short-term may be hurt by the "unprecedented" state of credit markets.

The case of American Home Mortgage Investment Corp. shows how the credit woes are spreading beyond subprime. As recently as last month, the mortgage lender -- which does not work with borrowers with bad credit -- had reaffirmed its 70-cent quarterly dividend. Last week, the Melville, N.Y.-based company filed for Chapter 11 bankruptcy court protection.

It got caught in a credit squeeze when falling home prices and a spike in payment defaults scared investors away from mortgage debt, including bonds and other securities backed by home loans. That led its lenders -- the banks that AHM had borrowed from to issue home loans -- to demand their money back and resulted in AHM's inability to deliver as much as $800 million in promised loans.

"We are seeing a crisis of confidence, which is leading to liquidity quickly being withdrawn from the mortgage market," said JMP Securities analyst Steven C. DeLaney.

But the clamping down on credit isn't isolated to mortgages. Consider that there hasn't been a high-yield debt offering since July 26, according to Thomson Financial.

That means that private-equity firms have been unable to tap debt markets to fund their buyouts, so they are slowing down the pace of dealmaking that they are doing. Such a pullback is contributing to the August slowdown for mergers and acquisitions, which have slumped to four-year lows. There were 289 deals announced so far this month totaling $18.4 billion, compared with 365 deals totaling $30.2 billion a year ago, Thomson Financial said.

At the same time, some already announced deals are under review. Atlanta-based Home Depot Inc. said it may change the terms and financing of its agreement for the sale of its HD Supply unit, which it said could result in a drop in the $10.3 billion sale price.

Stock investors don't like what is going on. They spent much of the last year giddy about the prospects of their companies getting scooped up for a nice premium.

Now, they have to face a new reality.

Associated Press