Personal Finance Advice

The Fed looks like it’s willing to pull out all the stops during the current financial crisis but despite all that, a tight credit market will continue for some time.  Financial institutions will remain cautious with their capital until the final costs of the sub prime mortgage collapse is fully realized.

The lesson of Bear Stern’s near collapse fresh in their minds, financial institutions are hoarding their cash waiting for the next round of write downs.  Banks are reluctant to enter into long term loans when they might need those funds in the near future to meet margin calls or otherwise suffer Bear’s fate. 

Securitization allowed banks to transform a bundle of illiquid loans into a series of liquid securities tradable on secondary markets.  Demand for any sort of collaterized debt has pretty much dried up, making it difficult for banks to roll over their loans.

Credit can be quite difficult to obtain these days for both individuals and corporations.  Mergers and acquisitions have slowed to a crawl due to lack of financing.  This also has an effect on business spending as many companies are having to delay work on capital projects.

The Fed may have slashed interest rates but mortgage rates still remain relatively high.  Even those with good credit ratings are finding it tough right now.  It’s hurting demand in an already weak housing market and will delay any sort of recovery.

Many analysts are predicting that the tight credit market will most likely continue past the end of this year and into the next.  Even if the economy doesn’t go into a recession, it will slow to a crawl for some time.

Starting in the 1970’s, the banking system has undergone a long cycle of deregulation.  The culmination of all this was the repeal of the Glass-Steagall Act in 1999 which has since muddied the distinctions between banks, securities firms and the insurance industry when they began a period of consolidation.

The arguments for deregulation was to foster a climate of competition, innovation and lower prices by lessening government oversight and allowing  market forces to dictate the flow of credit.  Since then financial sector has experienced a rapid expansion by offering many new products and services.

After this current financial crisis is over, I think we can expect things turn back the other way.  While the collapse of the housing bubble was the main cause of our current economic troubles, no one can deny that the financial sector has it’s fair share of the blame for all this.  Lax lending standards and excessive risk taking through the explosive growth of securitization and derivatives has created a highly leveraged financial machine that is at it’s breaking point.

Unfortunately because the financial system is so intertwined now, market forces can’t be allowed to reach their ultimate conclusion, the collapse of a large number of financial institutions, no matter how much they deserve to go out of business.  The Federal Reserve has had to step in and use powers it hasn’t needed since the Great Depression in order to keep the banking system from collapsing.

One thing is for certain though, the larger the final cost to taxpayers, the more lawmakers will call for an increase of regulatory oversight of the financial services industry and that might not necessarily be a bad thing.

The report released by the National Association of Realtors was the first bit of good news the housing market has seen in some time.  Home sales rose for the first time in seven months in the month of February.  Home prices are still falling though, which is a cause for concern.  The median sales price is down 8.2% from a year ago.

While this gives a glimpse that the housing market may soon be bottoming out, it doesn’t mean that sub prime crisis is over yet by a long shot.  All this really does at the moment is give the stock market a reason to rally for another day until the next bit of bad news comes along.

The problems with the banking sector are still there.  Only a week removed from the near bankruptcy of Bear Stearns, the financial sector is still gripped in a major credit crisis.

Many homeowners are still stuck with unwieldy mortgages that are worth more than the price of their homes, so the foreclosure risk remains.  So far, write downs from the sub prime collapse are estimated around $200 billion but many experts are predicting that figure could rise to as high as $500 billion before all is said and done.

While it appears that the Fed is willing to use any tool necessary to instill liquidity in the market, the fact remains that banks have tightened their lending standards considerably.  While the Fed has been slashing interest rates left and right, mortgage rates still remain abnormally high.

So while the slump in the housing market has caused the current troubles in the financial markets, it’s looking more and more likely that the financial markets will constrain a possible rebound in the housing market.