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Tuesday, August 07, 2007

WSJ: How Credit Got So Easy

by Calculated Risk on 8/07/2007 10:45:00 AM

From Greg Ip and Jon E. Hilsenrath at the WSJ: How Credit Got So Easy
And Why It's Tightening
. This article tries to explain how we got here. The authors discuss why the Fed set rates so low in 2001 and quotes Greenspan today:

"We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed."
The authors then discuss the changes in the mortgage business:
"All of us felt the suction from Wall Street. One day you would get an email saying, 'We will buy no-doc loans at 95% loan-to-value,' and an old-timer like me had never seen one," says Mr. Barnes [co-owner of a small Colorado mortgage bank]. "It wasn't long before the no-doc emails said 100%."
...
At first, delinquencies were surprisingly low. As a result, the credit ratings for bonds backed by the mortgages assumed a modest default rate. Standards for getting a mortgage fell. ...

The delinquency rate was a mirage: It was low mainly because home prices were rising so much that borrowers who fell behind could easily refinance. When home prices stopped rising in 2006, and fell in some regions, that game ended.
And they also touch on the easy credit for LBOs.
... lenders began to ease borrowing requirements. They agreed, for instance, to "covenant-lite debt," which dropped once-standard performance requirements, and "PIK-toggle" notes, which allowed borrowers to toggle interest payments on and off like a faucet.

Bankers began marketing debt deals for companies that, unlike Yellow Pages, didn't have comfortable cash flow. There was Chrysler, burning cash rather than producing it. And there was First Data Corp., whose post-takeover cash flow would barely cover interest payments and capital spending, according to Standard & Poor's LCD, a unit of S&P which tracks the high-yield market.

Last month, investors began to balk. Now many banks find themselves having committed to lend about $200 billion that they had intended to turn over to investors, but can't.
These are just a few short excerpts from a very good summary article.