Credit Crunch Could Chew Up Lenders

Credit where credit is not due.

Expect that to be the market's rueful motto in 2003, when the latest tidal wave of lending inevitably starts going bad. Since the economy began slowing back in 2001, banks and other lenders have continued making loans at a breakneck pace, spurred on, of course, by the historically low interest rates set by the Federal Reserve under Alan Greenspan. That poor discipline will come back to haunt financial institutions this year, you can bet.

There have been two overlapping credit bubbles in the last five years. The first mania -- loans to New Economy companies like Enron and WorldCom -- has already gone bust, and lending to such entities has dropped off sharply. But the second fixation -- personal and mortgage loans to consumers -- is still powering forward. Indeed, it has become one of the main drivers behind economic growth, which is why a coming slowdown in consumer loan growth promises to be damaging.

Unsafe at Any Speed

For instance, mortgage loans to households grew 12% from a year ago in the third quarter, hitting $5.85 trillion. That pace of expansion is much faster than that seen at any time during the '90s boom, and marks the fastest growth in 12 years. As a result, the housing market is looking decidedly bubbly.

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Credit Crunch Could Chew Up Lenders

The nation's median existing-home price jumped 9.8% in October from the year-ago period, compared with a 2% rise in inflation. October's increase was the biggest since 1987, according to the National Association of Realtors.

Meanwhile, mortgage delinquencies and foreclosures are at multiyear highs, and unemployment, the main cause of mortgage defaults, unexpectedly rose to 6% in November.

Despite this, financial institutions have continued to focus on borrowers with poor credit -- the so-called subprime market -- even though a number of lenders to this group of debtors have experienced serious problems due to bad loans. Auto and credit card subprime loans have so far been the most frequent source of trouble in the segment.