The Economist, Implode-O-Meter, and NINJAS

This story in the current issue of The Economist offers further evidence of the fascination they have over there on the other side of the pond with Aaron's informative and "forthright" Implode-O-Meter - it's at least the second mention in the last month or so.

They seem even more thrilled to be sharing a new acronym - NINJAs - a word that may not be new to you, but that is new to me.

Another pounding
WHEN the man approaching you is wearing boxing gloves, it makes sense to duck. The crisis in the American subprime-mortgage market was clearly visible months ago. Too many homebuyers with a poor or non-existent payment record were lent too much money. But when the rating agencies on July 10th finally got round to acknowledging the problem, investors were clobbered. Shares briefly wobbled and the dollar sank. Swap spreads, a measure of risk aversion, reached their highest point since 2003. Credit derivatives, where much of the financial innovation in recent years has taken place, recoiled. Investors flocked to the haven of Treasury bonds.

Why were investors so slow to react? It seems they have been consistently blindsided by how widespread the subprime problems have become—as well as complacent about the potential spillover into other areas of the debt markets.


At first, investors thought the subprime issue was confined to a few lenders, but the forthright website www.lenderimplode.com suggests that 97 of them have now been hit. Then they thought that defaults would be confined to a few states in the Midwest but the crisis has spread to heavily populated California and Florida.

The second delay was caused by the way that mortgages had been repackaged and sold. Initially they were bundled into residential mortgage-backed securities or RMBSs; Moody's, a rating agency, downgraded 399 of these bonds, while Standard & Poor's, a rival, indicated it was preparing to downgrade some 612 bonds, worth $12 billion. These bonds are only a small portion of the mortgage-related market. But according to Josh Rosner of the investment firm Graham Fisher, the agencies suggested further downgrades were to come.
...
All this may reduce the pool of potential mortgage investors. This effect may be reinforced by other developments. In recent years, there has been a concerted effort to increase the share of homeowners in America from the post-war average of around 63% to 70%. Lending standards were relaxed and deposits were no longer required. The extreme was reached with so-called NINJA loans (borrowers needed no income, job or assets). The influx of new buyers pushed up house prices, which made lenders even more eager.
...
So it may take a while for the property of struggling borrowers to trickle onto the market. Jeffrey Kirsch of American Residential Equities, a company specialising in buying delinquent loans, says foreclosing a property can take more than three years. He doubts the housing market will bottom out until the first quarter of 2009.

The current fear is not so much that the housing market could drive America into recession, although that could still happen. The worry is more that credit conditions may get tighter. The spread paid by higher-risk European firms has increased by almost a percentage point since mid-June. Investors are shying away from some loans being offered to finance leveraged buy-outs. A slowdown in such private equity-driven bids would hit the stockmarket.

Richard Bernstein, a Merrill Lynch strategist, says excessive lending has been fuelling the growth in financial markets in recent years. But he fears that now liquidity is drying up. That means no cushion when the punch lands.

Yikes! Now they're talking about a recovery not starting until 2009!

ooo

This week's cartoon: