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Lending crisis ignites broad economic fears

Stocks dive as data show more home loans in delinquency and new foreclosures at a record.

March 14, 2007|Walter Hamilton, E. Scott Reckard and Molly Hennessy-Fiske | Times Staff Writers

Economists have been arguing for weeks about the crisis in mortgage lending to risky borrowers and whether it could turn the entire economy sour.

Wall Street cast its vote Tuesday: It looks like trouble.

The Dow Jones industrial average sank almost 250 points after reports showed rising mortgage delinquencies and weak retail sales, suggesting that the woes of sub-prime lenders might be spilling into the broader economy.

Sub-prime lenders make loans to people with shaky credit or erratic income and have been wracked by defaults. Although sub-prime loans make up only about 1 in 5 new mortgages nationally, the rise in defaults could damage the overall housing market as foreclosures weaken home prices and risky borrowers are unable to get new loans.

That in turn could crimp consumer spending, the biggest driver of the U.S. economy.

"People have been using their homes as their banks," said retail industry analyst Adrienne Tennant. "When you figure you can't refinance for the third time, you start wondering, 'Oh, how am I going to pay for all this?' "

Christian Weller, a senior economist at the liberal Center for American Progress in Washington, likened the housing market to the parlor game of Jenga, in which wooden pieces are piled into a tower, then removed one by one.

Fewer loans. Fewer sales. Lower prices.

"We know the bottom part is being pulled out," Weller said. "We don't know if the top is going to come crashing down on us."

For weeks there have been almost daily reports of sub-prime lenders going out of business because of losses caused by customers who couldn't make their payments.

Another shoe dropped Tuesday. Accredited Home Lenders Holding Co. of San Diego, long regarded as one of the strongest sub-prime lenders, said it no longer met the profitability standards set by the Wall Street firms that provided its capital.

The company said it was exploring options to raise new money but could offer no assurance that it would succeed.

Accredited's shares tumbled $7.43, or 65%, to $3.97. Also Tuesday, shares of Irvine-based New Century Financial Corp. -- once the biggest independent sub-prime lender -- were removed from the list of stocks traded on the New York Stock Exchange, which cited concerns about New Century's financial viability. New Century also said it had received a grand jury subpoena, indicating that a criminal probe into its accounting practices and stock trading by company insiders was intensifying.

Later in the day, the Mortgage Bankers Assn. said 4.95% of mortgage loans had late payments in the last three months of 2006, up from 4.67% the previous quarter and 4.7% in the fourth quarter of 2005. It was the worst showing since spring 2003.

The percentage of mortgages entering foreclosure during the fourth quarter climbed to 0.54%, the highest since the group began issuing reports in 1972. For sub-prime loans, the figure was 2% -- nearly four times as high.

"The big question is whether it's an early indication of middle-income and lower-income people setting up for defaults," said Marc Pado, market strategist at trading firm Cantor Fitzgerald.

Fewer Californians were behind on their loans than were U.S. homeowners overall. Of the state's 5.6 million mortgages, 3.25% were delinquent, or had payments past due, and 0.15% entered foreclosure during the period. Among the state's 806,022 sub-prime home loans, nearly 11% were delinquent, compared with 13% nationally.

The foreclosure data helped make a bad day on Wall Street worse. The Dow Jones industrials tumbled 242.66 points, or 2%, to 12,075.96. That was the index's biggest decline since its 416-point plunge Feb. 27, the worst one-day loss in four years.

Financial and housing stocks -- among the most vulnerable sectors in an economic downturn -- suffered the worst blows.

"You've got a whiff of panic," said David Dreman, chief investment officer at Dreman Value Management. "Investors are starting to think the repercussions of sub-prime mortgage could go much further."

Dreman and other analysts put the blame for Tuesday's sell-off largely on the sub-prime industry and anxiety about its effects on the broader economy. By comparison, there were several factors behind the Feb. 27 stock plunge, including plummeting share prices in China and a report showing weak demand for big-ticket factory goods.

Investors Tuesday were also unsettled by a government report showing that retail sales edged up 0.1% in February from January's level. That was less than economists had forecast and, despite being partially the result of bad weather, was viewed as a sign that consumers were reining in their spending.

Although some observers think that number will bounce back this month, economist Scott Hoyt sees a continued slowdown in retail spending. Consumers are already burdened by high debt and high gasoline prices, he noted.

So far, the turmoil in sub-prime lending has mostly involved people with modest incomes, he said. But that could quickly change.

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