This is what you call "contagion."
With revelations throughout the past week that the housing recession is intensifying and infecting stock and bond investments, as well as lending practices, investors have focused on what could go wrong.
"Recession chatter is surfacing," said Merrill Lynch economist David Rosenberg.
With homeowners still facing mortgage adjustments of an extra 5 or 6 percentage points on their mortgage interest rate, consumers could face more foreclosures and struggle so much with monthly payments that they will cut back sharply on purchases.
There was evidence of that in last week's consumer spending data. On an annualized basis, spending was up just 1.3 percent--the lowest number recorded in a year. Meanwhile, analysts worry that businesses could cut back, too, if they have fewer avid customers and have to spend more to borrow money--an outgrowth of today's nervous lenders.
"It is kind of scary," said Peter Anderson, chief investment officer for RBC, a part of Allianz SE, a German insurance company. "I am normally very bullish, but you have to be careful here. These are real dangers here."
Even as market indexes rose Wednesday, for example, investors were selling the stocks on the New York Stock Exchange by 3 to 1. That is called bad market breadth--a lot more selling than buying, and an indication that investors are leery of most stocks.
Financial stocks in particular were on decline, as American Home Mortgage Investment Corp. said that it might have to liquidate its assets, and more hedge funds revealed subprime-related messes. Analysts also estimated that insurance company American International Group Inc. had lost between $1 billion and $2.3 billion on subprime mortgage-related securities.
Financial stocks are down more than 8 percent for the year, and are declining worldwide as institutions as far away as an Australian hedge fund choke on U.S. mortgage investment problems.
Meanwhile, the Case-Shiller index of home prices for May was released during the week, and showed housing prices down 2.8 percent over the past year nationally, and as much as 11 percent in Detroit. The stocks of homebuilders and mortgage companies have dropped about 60 percent from their highs. On Wednesday, investors knocked the stock of Beazer Homes USA Inc. down as much as 42 percent when a rumor surfaced that the company was going to file for bankruptcy. The company denied it and the stock ended the day down 18 percent.
Rumors were flowing throughout the week as investment bankers and traders headed to Internet sites such as dealbreaker.com and wallstfolly.com for insight.
The good news last week was that Citadel Investment Group, a giant hedge fund, said it would buy most of the assets of the injured Sowood Capital hedge fund. The bad news, which wasn't lost in Internet chatter, was that Sowood has been considered an outgrowth of the Harvard hedging brainpower that has been lauded and copied by pension funds and wealthy individuals during the last few years.
Also causing a buzz was the revelation that the bonds of some of the nation's premier investment banking firms have been trading like junk. The banks, such as JPMorgan Chase, got stuck in a downturn of confidence, agreeing to loan billions of dollars to private equity firms doing deals, and then not being able to unload the obligation--as planned--to bond investors.
"That could leave the burden on their balance sheets," Anderson said. Also troubling, he noted, was increasing evidence that the lax lending which caused a mess in mortgage loans also has been happening in commercial loans, too--with lenders tossing more loans to developers than their property has been worth.
With the tap turned off on the flow of easy money, and caution now well-entrenched on Wall Street, Merrill Lynch strategist Richard Bernstein told clients in a note last week not to expect the good old days of effortless borrowing to return for five years.
And he warned stock investors not to ignore the message bond markets are sending about the risks to investors.
Investors buying high-yield bonds are now seeking yields about 1.5 percentage points above the levels they accepted just a couple of weeks ago.
"There is no more argument about contagion," Rosenberg said. Investors are demanding higher yields on risky bonds from the U.S. and in emerging markets too.
"The reappraisal of risk means that lending growth is going to pull back and this will have macro repercussion," Rosenberg said. He noted news that Nomura is thinking about pulling out of the mortgage market entirely and Wells Fargo, one of the largest U.S. mortgage lenders, is shuttering its subprime wholesale lending business.
Meanwhile, Rosenberg, who started predicting outcomes like these in 2004 as consumer appetite for risky mortgages grew, said he thinks the housing troubles are far from over.
He noted that housing affordability continues to deteriorate, even though unsold homes on the market keep mounting.
Unsold inventory of single-family homes has risen to 8.7 months' supply from 6.5 months' supply at the beginning of the year. The build-up in unsold homes has not risen as fast since 1990, a severe housing recession.
Meanwhile, as mortgage delinquencies build among people with bad credit and even those who were considered more stable borrowers, he notes the problems have just begun.
Billions of dollars in mortgages are yet to reset to higher levels.
"If you thought that the $111 billion of mortgage rollovers created some indigestion in the second quarter, look out because they balloon to $126 billion in the third quarter and $138 billion in the fourth quarter," Rosenberg said.
And in the middle two quarters of 2008, there will be another $322 billion in resets.
Gail MarksJarvis is a Your Money columnist and the author of "Saving for Retirement Without Living Like a Pauper or Winning the Lottery." Contact her at email@example.com.