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Fear of greater risk driving investors more than actual risk
NEW YORK -- The widening fallout in the U.S. mortgage industry has reminded investors of a risk they had forgotten: the fear of risk itself.
As unpaid mortgages and bankrupt lenders bring the weakest segments of the mortgage industry to its knees, investors have begun dumping debt and other investments that would seem to have nothing to do with home loans.
Corporations are paying higher interest rates on their bonds, some private-equity firms are having trouble raising money to close big purchases and the stock market has lost 7 percent of its value in less than two weeks -- all mainly because of an exodus from risk.
"I would characterize it as a loss of excessive risk appetite," said Ian Lyngen, an interest-rate strategist at RBS Greenwich Capital. "There is a lot more apprehension about layering on riskier assets."
The flight to safety in the financial markets in the past few weeks can be traced to "subprime" mortgage lending.
Subprime refers to people with spotty credit histories. Fueled by Wall Street's easy money, the subprime mortgage market exploded to $1.3 trillion over the past few years. But as home prices sagged and more borrowers missed payments on these loans, the industry fell into turmoil this year.
The meltdown of this comparatively small segment of the U.S. economy is contributing to a much bigger and broader issue: Lenders around the world are growing scared to lend.
"It is making people pull in their tolerance for risk," said Doug Sandler, Wachovia's chief equity strategist. But Sandler thinks investors had been way too eager take on risk without enough compensation.
Far from crashing, he said the market is returning to normal. Important voices agree.
"We have the strongest global economy I've seen in my business lifetime today," Treasury Secretary Henry Paulson -- the former CEO of Goldman Sachs -- told reporters in Beijing on Wednesday. "We have a healthy economy. What is going on in my judgment is a reassessment of risk."
There are plentiful examples of the effect that reassessment is having.
Insuring against a defaulted loan using something called a credit-default swap has become pricier. Treasury bonds -- the safest investment in the world -- have grown more expensive.
Robert Bach, senior vice president of research at real estate services firm Grubb & Ellis, said some of the lenders he works with will not even quote a loan right now.
And a measure of volatility known as the VIX has skyrocketed by nearly two-thirds in the past two weeks to reach its highest level in more than four years.
"There has been a change in attitude," said Eric Thorne, investment strategist at Bryn Mawr Trust. "We were in a situation a couple of weeks ago where there wasn't much that investors were worried about. It's more a psychological impact of the lending environment in general."