Commentary

Giant Mortgage Lender Files For Bankruptcy

American Home Mortgage, one of the largest mortgage lenders – and a glaring symbol of unsound business practices- filed for bankruptcy early this week. Mortgage lenders like American Home Mortgage are responsible for helping to inflate the largest housing bubble in American history. Now investors are running from the crappy mortgage-backed securities originating from these companies – deflating the credit bubble that drove real estate prices to the moon. This will drive up the cost of buying a home and will reduce the availability of credit to the rest of the economy.

The mortgage lending industry’s business model focused on issuing copious amounts of credit, in the form of subprime mortgages, to unqualified homebuyers, and quickly selling these time bombs to eager Wall Street investment banks. These firms repackaged them as mortgage-backed securities, and quickly off-loaded them to a wide range of investors, including hedge funds, pension funds and even central banks.

Investors who were once tripping over one another to buy securities backed by subprime mortgages are now turning their backs on them. They are demanding higher yields for new offerings, increasing the cost of credit to the real estate market. It seems as though the quest for additional returns is not worth the considerable amount of risk involved.

The slowdown of the easy money train is spreading to the once unstoppable flow of leveraged private equity deals that have provided countless millions in fees to investment bankers the world over, and a significant lift to share prices. Globally, a total of forty-six leveraged buyouts, weighing in at a value of $60 billion, have been shelved since the start of July.

On Main Street, credit still seems readily available. A day does not pass without a parade of “no money down” ads from retailers of every stripe marching across TV and computer screens. The tightening of credit that is affecting housing, and now the stock market, will work its way to the mall near you. You see, the vast majority of credit available to the U.S. economy flows from capital markets, not the banking system, as it had in the past.

The availability of credit moves in cycles. The past several years witnessed a deluge of easy money, creating a credit bubble, fueling a housing bubble that propelled the real estate market to nosebleed territory. The credit bubble also swelled stock market prices and commodity prices. (It also filled American homes with flat panel TVs and chrome-plated accessories.) Now the generous lending spigots that have propped up the economy are turning off. The myopic soothsayers on Wall Street are sanguine as this storm gathers pace. But, as the tide of easy money rolls out, not even the yachts will remain afloat.

© 2007 Splendid Marbles.