Time for caution for consumers: Wall St.'s black hole hits Main St.
BY SUSAN TOMPOR
FREE PRESS COLUMNIST
After watching Wall Street get whacked by a frantic 500-point drop on Monday, we'd all like to know what moves we should make on Main Street.
The short -- and yes, glib -- answer: Now is not the time to go shopping.
Not for a boatload of bargain-basement stocks. Not for a deal on a dream house. Not for much of anything.
"Anybody who thinks the housing crisis is over is on some kind of illegal drug," said W. Howard Morris, chief investment officer for Prairie & Tireman, a money management firm in Detroit.
The mess that began more than a year ago with the subprime mortgage slop is dragging the broader financial system deep into the mud, far deeper than anyone dreamed possible.
It's a reminder that the economy and the safety of the financial system -- not lipstick -- should be top campaign issues.
After news of a Chapter 11 bankruptcy filing at Lehman Brothers Holdings Inc. and the sale of Merrill Lynch & Co., the Dow Jones Industrial Average on Monday fell 504.48 points, or 4.42%, closing at 10,917.51.
It was the worst point drop since the Dow lost 684.81 points on Sept. 17, 2001, the first day of trading after the 9/11 terrorist attacks.
It also was the sixth-largest point drop ever for the Dow, behind the 508-point fall in the October 1987 crash.
The Dow has tumbled by 3,247.02 points, or nearly 23%, since Oct. 9, 2007, when the blue-chip index closed at a record 14,164.53 points.
Federal Reserve response
We know it's more likely now that the Federal Reserve will knock down interest rates today.
The federal funds rate -- the rate banks charge each other on overnight loans -- has dropped to 2% from 5.25% last summer.
The short-term rate could hit 1.5% or 1.75% today, according to Diane Swonk, chief economist for Mesirow Financial in Chicago.
We don't know when consumers who have good-but-not-pristine credit will once again be able to easily get a mortgage or a car loan.
David Sowerby, portfolio manager for Loomis, Sayles & Co. in Bloomfield Hills, predicted it could take six to nine months for banks to be more willing to lend.
We do know, all too well, that the so-called Wall Street bigwigs did it to us again.
Economists readily admit that even now -- even after Lehman, even after Bank of America Corp. agreed to buy Merrill Lynch and even after last week's federal bailout of Freddie Mac and Fannie Mae -- no one really knows how many billions of dollars in mortgage-related assets financial institutions have really lost.
It's a black hole.
It's as if a family had no idea just how much money it really owed on its mortgage, car loans and credit card debt. Talk about reassuring.
Cheap credit cost everyone -- even those who didn't borrow a dime -- a fortune.
Financial firms and mortgage brokers once raked in the cash by making real estate loans and holding assets bought with borrowed money. Deals were heavily leveraged and the collateral tended to be big investments in mortgage-related securities.
Domino effect
And then home values fell, foreclosures went up and the credit crunch made it harder for many people to get a mortgage.
"The domino effect in the decline in housing prices is greater than anyone could have predicted," said Morris, the Detroit investment officer.
As the housing crisis unfolded, the value of mortgage-related securities kept going down and down. And investment firms needed to raise more capital. For a while, they could turn to foreign investors. But now, it's getting even tougher to raise that money overseas. Lehman couldn't find a buyer.
It's sort of like somebody who borrows heavily to buy a home. You're going to lose what little equity you had when the housing market hits the skids. And if you didn't have much equity in the first place, you're not going to borrow any more if your home's value has fallen dramatically.
"The credit crisis has crippled the financial sector," said Eugenio J. Alemán, senior economist for Wells Fargo in Minneapolis. "They are not lending because they can't."
So far, the world's biggest banks and brokerages have reported more than $510 billion of write-downs and credit losses on securities tied to mortgages. Lehman still had a $50-billion stockpile of such mortgage-related investments last month.
We're seeing more fallout daily. The Federal Reserve on Monday asked Goldman Sachs Group Inc. and J.P. Morgan Chase to help make $70 billion to $75 billion in loans available to giant insurer American International Group, according to the Wall Street Journal, which quoted people familiar with the situation. AIG shares fell nearly 61% on Monday. AIG closed at $4.76 a share, down $7.38 a share on Monday.
Consumers on Main Street have no choice but to move cautiously. They're stuck paying down their own debt -- and praying that they don't lose a job in the fallout.
Contact SUSAN TOMPOR at 313-222-8876 or stompor@freepress.com.
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