As news of the continued troubles in the subprime mortgage markets spreads, most people don’t expect to be affected by it, since they don’t have a subprime loan. Commercial borrowers may especially wonder how problems in the residential markets could affect them: “How could someone else’s bad mortgage affect my business?”
What has happened? Almost everyone knows this part of the story by now. Throughout the housing boom, some residential lenders lured subprime borrowers to the table with low, adjustable rates. Residential lenders then bundled them together and sold them on the financial markets as securities.
When the fixed periods for these rates ended, recent rate increases (for example, the Federal Reserve raised its key rate for 17 consecutive quarters from 2004 to June 2006, from 1% to 5.25%) drove interest payments your home beyond its capacity. pay. Although many of these borrowers were able to refinance with fixed-rate mortgages, many were not so lucky. Combined with a downturn in the real estate market, these homeowners found themselves stuck with a mortgage they couldn’t afford. This has led to the “subprime mortgage crash” we are all hearing about.
So what does that have to do with leasing my forklift or refinancing my warehouse, the businessman asks? Well, over time, financial markets have become global, just like any other market. Many of the same investors who bought those subprime mortgage securities buy commercial loan securities or invest in private lenders or equity firms. Now, these funding sources have gotten skittish, wondering if they should hold on to more of their money, in case something else happens. In addition, as subprime securities exceeded their expected default levels and investors stopped buying new securities, lenders were left with billions of dollars in securitized mortgages on their books and were unable to cash them in to replenish their funds for new loans – residential or commercial.
That means a decrease in supply, and as all business owners know, that leads to increased prices. Also, as with many markets, there is sometimes a “knuckle” reaction to raise prices because everyone knows prices are raised in this type of situation. This is causing what many economists call a “liquidity squeeze.” A “liquidity squeeze” is when the riskiest borrowers are squeezed out of the market.
What’s next? Well, there are two main paths this could take, good and bad, with different levels of bread to go around. The wrong track is that the subprime problem is more massive than anyone can foresee, that millions more are on the brink of foreclosure, and that we are moving from a “liquidity squeeze” to a “credit crunch.” , which is where anyone can get a loan.
The good news is that this is a temporary blip in the financial markets and once the dust settles and everyone sees that there are no more shoes to drop, things can go back to normal (normal pre-boom with stricter underwriting standards) and rates will go down a bit again (still less money will be available and its owners will be more risk averse).
What will it be? That’s a tough call for seasoned economists, but the consensus from what I’m reading and hearing from them in person is that we’ll be on the right track. Based on your arguments, I will side with the optimists on this one.
Because? Bullish economists point to a number of factors: 1) the US and global economies remain strong overall: In the US, inflation is low (although not low enough for the Fed to hold back). get excited about lower rates, though that may be changing). 2) the Federal Reserve has room to cut rates if necessary to improve liquidity; 3) it is estimated that a significant number of subprime borrowers were able to refinance their mortgages; 4) as a percentage of overall global financial markets, subprime residential securities are a relatively small segment (according to Conference Board economist Ken Goldstein in a recent CNNMoney.com article, subprime securities make up only 10 % to 15% of a $10 trillion mortgage market and of that, only 15% is at risk); 5) a portion of these subprime borrowers were multi-loan investors who had too much inventory rather than primary owners; 6) while everyone agrees that home sales will slow, many of the construction job losses associated with reduced home starts have been absorbed by the economy; and 7) a complete housing market collapse is usually caused by people losing their jobs in large numbers, which is not happening.
Against this, pessimistic economists point to the impact reduced consumer spending due to higher home payments and reduced home equity (thanks to substantial drops in home prices) will have on the economy. of the dwelling). However, as one economist pointed out at a recent commercial real estate event, the economy was already transitioning from the “consumer spending” phase to the “business expansion” phase and is not as reliant on consumers to keep it going. He mentioned that the “massive” drops in the number of home sales are returning us to what were considered great pre-boom levels (ie, they’ve spoiled us). Also, people must be afraid of losing their jobs and not seeing their income grow to really cut spending. Neither of these is the case and the Conference Board recently reported that consumer confidence is at its highest point in six years.
What does all this mean for your business? If we follow the path of the bullish economists as I hope we do, this means that everyone will be forced to live with an increase in the cost of money in the short term (probably three to six months) and real difficulties in finding financing for less than perfect credit businesses or higher risk businesses until the markets calm down.
Deals that were hard to do two months ago may not even make it to the loan officer’s inbox, and even the easiest deals will take longer to fund. Lenders will want to demonstrate to their investors that they are doing all the necessary due diligence and will be sure to toughen their standards. It will be more important than ever to prepare a good package, clean and without surprises.
As the market corrects for the longer term, there will be more news about subprime delinquencies in 2008 as another $500 billion or more in “teaser rate” loans are reset in the market and it wouldn’t be surprising. hear that some hedge funds and private equity firms have closed their doors. However, now these are known issues and unless there are more surprises, the market will adjust in advance.
You can expect interest rates to be higher than before the subprime problem on average (lenders and investors are more likely to price more appropriately for risk) and tighter credit requirements to continue . It will mean the need to plan further down the line as deals will take longer to fund. Harder deals will be possible, but they will pay a higher risk premium and face far more attention than many in that market have been accused of receiving.
However, we should get out of this “liquidity squeeze” and good deals with good packages will continue to move forward, albeit with a little more scrutiny.
