Easy Money, Lifeblood Of Economy, Is Drying Up

But regulators and analysts say it is becoming clear that the housing downturn and problems in the related mortgage market will be more prolonged and uglier than they had thought. That has investors worried about rising defaults on risky mortgages infecting the credit market, and in turn, dragging down the economy.

With home prices falling in many parts of the country, millions of subprime borrowers, those with shaky credit histories, are falling behind on their payments and losing their homes. In many cases, their homes are worth less than their loan balances, and with prices down, they cannot sell or refinance their way out of trouble.

This has caused a drop in the value of securities and bonds backed by the loans. During the housing boom, lenders issued loans in record amounts, often on very loose terms. Wall Street financial firms bought huge pools of the loans, repackaged them as bonds called mortgage-backed securities, and sold them to hedge funds and other investors.

Since 2000, more than $1.8 trillion worth of securities backed by subprime mortgages have been created, according to Inside Mortgage Finance.

Hedge funds made money off those securities by turning them into complex investment vehicles called derivatives and selling them to pension funds, insurance companies, foreign investors and others. The rise of such financial partners empowered the lending industry to sell even-riskier loans.

The failure of several highprofile hedge funds has highlighted how quickly things can turn. This month, two Bear Stearns hedge funds -- valued at $20 billion this spring -- told clients that their investments were worth pennies on the dollar, if that. The funds contained subprime-backed securities.

While many policymakers said problems would be limited to the riskiest borrowers, it appears that the more creditworthy prime borrowers also are struggling.

This week, Countrywide Financial, the nation's largest mortgage lender, said there were more borrowers with good credit falling behind on their home-equity loans.

That shook the markets because of Countrywide's size and its reputation as a shrewd lender. The thinking was that if Countrywide saw trouble spreading, "the problems are likely to spread even more," said David A. Hendler, senior analyst at CreditSights, a securities research firm.

Weakness in the housing market "will get materially more severe," Richard F. Syron, chairman and chief executive of Freddie Mac, said yesterday. The government-sponsored mortgage-funding company based in McLean holds about $712 billion of mortgage-related investments.

Freddie Mac is relatively insulated from the subprime segment of the mortgage market, but it has funded unconventional loans such as those on which borrowers pay only interest for a time instead of paying down the principal. At the margins, problems have been creeping from the weaker segments of the market into the stronger ones, Syron said.

"Housing prices will go down," he said. The result will not be "catastrophic," he said, "but it will have a measurable impact on how people spend money. It will have a material impact on how people spend on cars, how they spend on consumer appliances, how they spend on lots of things."

Federal Reserve Chairman Ben S. Bernanke told Congress last week that investors' and lenders' losses flowing from subprime credit problems are estimated to be $50 billion to $100 billion so far. But he also sought to allay concerns about widening credit risks, noting that "financing activity in the bond and business loan markets has remained fairly brisk."

Bernanke gave no reason to think that the problems in the housing and credit markets were bad enough to prompt a cut in the Fed's benchmark short-term interest rate, which has held steady for more than a year at 5.25 percent. He said the Fed was more concerned about inflation than the risk of weaker growth.

ElBoghdady reported from Washington. Staff writers Nell Henderson and David Hilzenrath in Washington contributed to this report.