Housing could be gateway to broader debt distress

By Pedro Nicolaci da Costa - Analysis

NEW YORK (Reuters) - The U.S. housing market crash has exposed the mortgage industry's suspect lending standards, and investors now fear credit cards, car loans, and student debt could be the next sectors to unravel.

If proof of income was shrugged off as a nuisance on home loans, lenders may have been even less scrupulous in other areas of consumer finance, and the eagerness to increase profits may have clouded their assessment of risk.

"Investors are increasingly wondering whether consumer credit is the next shoe to drop," said Stephen Gallagher, chief U.S. economist at Societe Generale.

Consumers are at the center of concerns over a U.S. economic recession that seems increasingly hard to avoid. With total consumer credit hovering at $2.5 trillion, equivalent to about one-fifth of national economic output, the worry is not a trivial one.

Of that $2.5 trillion around $800 billion is securitized, analysts said, meaning that like the subprime mortgages now tarnishing the financial sector, they were repackaged and resold as pools of bonds in the secondary market. This leaves both consumers and investors in a vulnerable position.

"You will see an ongoing increase in late and delinquent payments," said Eric Green, economist at Countrywide Financial in Calabasas, California.

A surprising 0.4 percent fall in retail sales during the Christmas holidays suggests some consumers are already in trouble, forcing them to cut back at a time of year when people usually spend more freely. This belt-tightening has stirred uncomfortable memories of housing bonds gone bad.

The possibility of a housing-like debacle in consumer credit markets seemed all too real last week after credit card giants American Express and Capital One projected subpar profits, citing mounting consumer loan losses as the U.S. economy slows.

"Everything got really lax," said William Ryan, consumer-finance analyst at research firm Portales Partners.

"Late in the economic cycle, companies stretch for that last dollar of growth. How do you do that? You relax underwriting standards, you give it to the marginal buyer."

Amex Chief Executive Kenneth Chenault has warned that the consumers in states like California and Florida, which have been hardest hit by the housing slump, are showing increasing financial stress.

Citigroup's earnings report for the fourth quarter, which marked the investment bank's first ever loss, also contained ominous signs, like a 65 percent rise in credit-related losses.

"The increase in credit costs primarily reflected a weakening of leading credit indicators, including increased delinquencies on first and second mortgages, unsecured personal loans, credit cards, and auto loans," the bank lamented.

Perversely, a widening securitization bust would punish borrowers by pushing up interest rates as investors demand higher returns for the perceived increase in risk. There is already some evidence that this is happening.

"As demand for securitizations started dropping, education lenders found it more difficult to find investors for the securitizations and had to offer higher margins," said Mark Kantrowitz, publisher of FinAid.org, a website providing student financial information.