Column: John Birdwood

Investors of a certain vintage will know that there's nothing new about the subprime boom and bust. Savings and loan associations in the 1980s went through a similar ordeal

On May 15, online property marketplace RealtyTrac recorded that 19,691 properties in Wayne County, Michigan (Detroit, for most purposes) were in foreclosure. The lender was in possession and offering the properties for sale at the outstanding loan value. The number of such properties has climbed steadily this year but few sales have been made.

Elsewhere in the country the cycle has moved on from foreclosure to auction. In San Diego an auction of nearly 100 foreclosed homes saw prices 30% below the previous sale or appraisal price being realised. In some cases the discounts were around 50%.

These are the real consequences of the collapse of the subprime loan market in the US, and it is hard to see how the market can recover swiftly. Many subprime lenders have simply gone out of business and major banks have tightened their lending standards. The Federal Reserve's Senior Loan Officer survey of US banks' lending practices in April 2007 revealed while lending standards for prime borrowers had actually eased a little, 60% of respondents reported that lending standards for subprime borrowers had tightened.

Further house price declines and loan losses seem probable. Yet little of this has spilled over into wider credit markets. Most categories of credit have outperformed US Treasuries this year. The economy too, while growing more slowly, shows little sign of serious damage. Some observers express surprise that there have not been wider ramifications.

Deja vu

Those with long memories have seen this before. In the 1980s the deregulation of the savings and loan industry (the mortgage lenders of a previous generation) had lead to an extraordinary boom in lending. Between 1982 and 1985 industry assets rose 56%. In Texas, for example, 40 savings and loan associations saw their balance sheets triple; some of them grew by 100% a year. There was the inevitable payback from over-rapid expansion, lax lending standards, poor risk control, inappropriate regulation and fraud.

By 1987, the consequences of overexpansion of mortgage lending in Texas, aided by the effects of an oil price collapse, led to a situation where the state accounted for more than half of the S&L association losses nationwide. Texas itself was in a major recession; the office vacancy rate was over 30% and real estate prices collapsed.

The effect on the wider economy and risk assets was limited. True there was a period of sub par growth (as now) in the middle of the decade and the equity market had a brutal setback, but then recovered.

The message is that the US economy and markets are remarkably resilient in the face of a single shock but joint shocks are quite another matter - especially at a time when monetary policy is tight, the corporate sector is leveraged and demand is faltering.

Are we there yet? I would suggest not. The corporate sector has only recently started to releverage again - this is a process which normally lasts for several years. There are few signs of excess in the corporate sector, in terms of labour or capital spending. Significant changes in fiscal and monetary policy seem unlikely for some time to come - and neither can be described as seriously restrictive. Apart from the invisible risk of an accident arising in the nexus of highly leveraged structured instruments and the financial sector the risk of an endogenous shock in the US still seems fairly low.

- John Birdwood is director of fixed income and currency at Baring Asset Management in London.