Mixed Signals

Mixed signals are what I’m getting on the U.S. economic impact from problems developing with domestic lenders.

On the one hand, we have U.S. Treasury Secretary Henry Paulson expecting problems with the subprime mortgage to be “contained” and not cause a problem for the U.S. banking system. At least that’s what he told the media during his tour of Asia.

On the other hand, we have Fed Chairman Bernanke warning both Fannie Mac and Freddie Mac to hedge their assets against the risk of interest rate hikes, as problems with these lenders could “destabilize” the markets. That’s what Bernanke said in his speech to the Independent Community Bankers of America in Honolulu last week.

Fannie Mae and Freddie Mac are the largest sources of money for Americans buying homes. Bernanke says the two lenders should focus on lending to low-income Americans and reduce their exposure to derivative investments.

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Maybe Paulson and Bernanke are both right. I don’t know how bad the effects of the subprime lender problems will be. And I’m not sure how much a problem Fannie Mae and Freddie Mac will become (but the potential for catastrophe is there).

But I do know this: The shares of subprime lenders (which are companies that loan money to problem-income people) are getting clobbered on the stock market. On Friday, New Century Financial, the second largest subprime lender in the U.S., stopped taking new loan applications. Bankruptcy may be an option.

With borrowing in the U.S. becoming more difficult each passing day, those who borrowed with low or poor credit ratings in order to buy homes during the real estate boom will now have severe problems refinancing. There’s no mixed signal about this: Foreclosures in the U.S. will continue to rise, the real estate market will get weaker, and the U.S. economy will get weaker. Smart investors should seriously start considering unloading their stocks of consumer-products companies that produce nonessential goods.