A Market Bottom? Problems Persist

Historically, the collapse of a major financial institution, like Bear Stearns a week ago, would mark the bottom of the panic. Such events trigger a monumental policy response that leads to an upturn. We're seeing that response unfold now.

But the root of the crisis, foreclosures and falling prices for houses, is not showing any signs of abating just yet. The longer the freefall continues, the further it undermines mortgage-backed securities [MBS] as an asset class (and in turn the balance sheets of institutions with large MBS holdings -- many of which have borrowed against them).

Moreover, the financial crisis is radiating outward from the MBS epicenter. Wobbly dominos now include non-bank lenders such as CIT Group, regional homebuilders/banks, condo developers/banks, and local governments with interest-rate swaps. Here are some recent news reports on the spreading contagion (subscription required access to most links):

The Well Gets Shallower CIT Group Inc. … a major lender that specializes in providing financing to companies …. Its normal sources of funding have dried up … forcing draw down its entire $7.3 billion line of backup credit ..."It's a ripple effect," says Michael Taiano, an analyst at Sandler O'Neill & Partners. "CIT gets squeezed, the people they lend to get squeezed and end up maybe defaulting on their loans."

Mortgage Mess Hits Home For Nation's Small Builders Many of the nation's small and midsize home builders are on the ropes … regional banks, until now mostly insulated from the subprime fallout, are seeing rising delinquencies on construction loans … could contribute to a credit squeeze in towns across the U.S …. Analysts say as many as 150 (regional) banks could fail over the next three years.

Woes in Condo Market Build As New Supply Floods Cities The condominium market is about to get worse as many cities brace for a flood of new supply this year …. It comes on top of unprecedented supply …. The deluge means bad news for developers and potentially lower prices …. If defaults and foreclosures rise, lenders will feel the pain too.

Swaps Backfire As Cost Saver On Public Debt Already reeling from bond-insurance trouble and faltering credit markets, municipalities face another concern: A popular derivatives strategy has suddenly turned sour. The trade, known as an interest-rate swap, is supposed to help local governments, schools, museums and hospitals lower borrowing costs. More recently, the turmoil … has caused the use of certain swaps to backfire, forcing issuers to pay much higher rates.