American Home Mortgage is the latest -- but undoubtedly not the last -- corporate casualty of the subprime mortgage crisis.
The Melville, N.Y.-based company declared bankruptcy Thursday and said it would cut its employee base from 7,000 to about 750. It plans to maintain its thrift and mortgage servicing businesses.
"It is with great sadness that American Home has had to take this action which involves so many dedicated employees," said Michael Strauss, American Home's Chief Executive Officer, on the company's website.
"Unfortunately, the market conditions in both the secondary mortgage market as well as the national real estate market have deteriorated to the point that we have no realistic alternative," he said.
Economists fear the deepening gloom in the mortgage sector will spread to other parts of the economy, as investors -- who provide much of the money that lenders lend -- pull back from all but the primest of the prime loan portfolios.
If lenders have no money to lend, it will make it difficult for consumers and businesses to buy the homes, cars and equipment that keep the economy moving.
Worse yet, many lenders need to constantly refinance their portfolio, raising money from investors to cover their outstanding obligations. If investors don't cough up the funds, more lenders and hedge funds may follow American Home and others into the history books.
Federal Reserve Chairman Ben Bernanke warned last month that the continuing doldrums of the housing market, particularly the collapse of the subprime mortgage sector, will dampen economic growth.
"The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards and the recent increase in mortgage interest rates," Bernanke said in a report to the House Financial Services Committee.
Consumers Get Squeezed
As the cash drought worsens, the effects are felt throughout the economy:
• lenders begin leaning on homeowners who are a month or two behind in their mortgage payments;
• home prices fall as mortgages get tougher to come by;
• even though prices are lower, modest-income consumers still can't afford a home because of tougher mortgage restrictions;
• foreclosures increase as consumers are squeezed by fast-rising payments on their variable-interest-rate mortages;
• banks raise the interest rate on credit cards, even for their good customers; and
• consumers find it harder to buy big-ticket items like cars and appliances on favorable terms, cutting into sales and wiping out profits for retailers and manufacturers.
So far, the response to all this by the Federal Reserve has been to implicity blame consumers for taking out mortgages they can't afford.
In his ruminations last month, Bernanke described how the Federal Reserve was addressing the subprime issue, including revising mortgage lending disclosures as part of the Truth In Lending Act (TILA).
"By the end of the year, we will propose changes to TILA rules to address concerns about mortgage loan advertisements and solicitations that may be incomplete or misleading and to require lenders to provide mortgage disclosures more quickly so that consumers can get the information they need when it is most useful to them," he said.
Whether the equivalent of a warning label is enough to turn the situation around remains to be seen.
