I have posted this article on www.articlewheel.com, the issues contained concern me although it is not directly related to theusual content of this site, or my homepage. Feel free to reproduce it in whole or in part. References are from the FT and Wikipedia.

“Accredited Home Loan Lending, a subprime mortgage specialist, said it was seeking fresh capital and waivers on its lending covenants, while the New York Stock Exchange said it planned to delist shares in New Century Financial”. This bland statement of fact comes from one of the lead stories in todays Financial Times.

Current news reporting covering the meltdown of the US suprime mortgage lending does not go far enough. The fact that New Century Financial has over extended itself is not completely surprising given the boom in sub-prime credit in recent years along with stories of mortgage brokers driving Ferraris and living  millionaire lifestyles.  The bigger issue is that bad debt levels across the mortgage sector are unfeasibly high, with the latest figures showing US mortgage market delinquencies at 4.95% in Q4 of 2006 up from 4.67% in the previous quarter.

To put this in perspective, when I used to work in the mortgage sector in the UK we would price mortgages based upon a 1% delinquency rate, compared to say 4 or 5% for personal loans. This means that the US mortgage market as a whole is running at delinquency rates comparable with an insecured credit portfolio. The sub prime sector reached 14.4% delinquent in Q4 up from 13.2% in quarter 3; which is higher than would be profitable for a badly performing credit card portfolio (typically expect 5-7% delinquent).

OK, so the mortgage market is in trouble, they have priced incorrectly and will suffer some losses. Banks make a lot of money and they can eat the loss right? 10 or 15 years ago this would be a reasonable standpoint but in the interim banks have been developing and heavily promoting the sale of secruitised debt. This put simply means that they sell the rights to future cashflows from their mortgage portfolios to other institutions or rich individuals. For the banks this means that they  increase the amount of lending they do and the promise to investors was cast iron financial instruments secured on individual properties. The breadth of institutions that have invested in these instruments is vast and includes Life Assurers, Retailers, Investment banks, Governments (local and federal/sovereign) as well as rich individuals.

Again I hear you thinking that these institutions are large and can afford to lose a few dollars if the mortgage market suffers a few wrinkles, but there is a bigger picture. Interest rates are on an upwards trend around the globe and  that makes it harder for home owners to meet their monthly commitments. If the banks or their debt buyers push for a large scale round of repossessions the market could be flooded with cheap housing stocks, which in turn will depress the price of housing stocks putting many owners who have bought at the peak of the recent market boom into negative equity. The natural reaction at this point is to simply walk away, which will boost delinquency further and could create a downward cycle.

Under these circumstances it is forseeable that all the debt instruments, which only last year were being heralded as the financial success story of the decade, will effectively attain junk status and any companies that are holding them should see a swift correction to their stock price. On any kind of scale this could lead to a melt down in equities similar, if not more severe than the housing stock crisis outlined above.

Defined contribution pension funds that have become the norm are generally invested in equities and bonds but with recent relaxing of the rules some now permit property investments if not directly then in the form of Reits. Any major correction in either equity or housing markets could drastically affect the ability of millions of baby boomers to retire.

Taking our worst case scenario then, your house would be worth less than your mortgage, your investments decimated and nothing will have happened to alleviate your credit card balances. Your income will not have changed if you are lucky but you will be faced with a situation where you must save massively if you ever hope to retire. This mind set is what ultimately will curb US consumerism as we know it, and that ultimately will be the cause of depression across the United States.

It seems that no-one quite agrees on the causes of the great depression in the 1930s, but causes which are listed as contributing include: - lack of consumption caused by saving as opposed to spending, excessive borrowing by commercial entities and consumers exacerbated by deflation meaning that the debt levels spiralled as earnings dropped and borrowers were unable to repay the loans, and pretty soon Construction companies went under en-masse as demand for property fell off.

It is certainly not unforseeable that many of these factors could repeat given the current environment, added to which automated selling systems and the widespread use of complex derivative instruments have been shown to compound the speed with which the equity markets can head south.

There is little that you or I can do to forestall these events. Conventional wisdom says you can do one of two things. Either you trust in government to alleviate the pressure on the housing and debt markets caused by the failings of companies such as Accredited Home Lending and New Century financial, or you cash in all your chips now, wait for the crash and then buy “while there’s blood on the streets”. Either way I wish you luck.