US 'credit contagion'?

Markets will scrutinise two important measures of consumer and business confidence this week, in the face of renewed concerns that continued housing-sector weakness could create a broader 'credit contagion'. 

The largest US mortgage lender, Countrywide Financial, unsettled Wall Street early last week after it revealed that mortgage delinquencies were seeping from its 'sub-prime' portfolio of less creditworthy borrowers, into its portfolio of 'prime mortgages'.  While prime mortgage borrowers generally have very sound credit records and incomes, many were encouraged to take out 100% loan-to-value mortgages, which often featured 2-3 year 'teaser' fixed interest rates. Many of these rates are beginning to reset, in the context of sinking house prices, leaving homeowners with debts that exceed the value of their properties. 

Most lenders, such as Countrywide, have packaged and sold off a large portion of their credit risk in the form of asset-backed securities or structured credit products, such as collateralised debt obligations (CDOs).  This may have substantial benefits in terms of managing overall risk: the chance that a large financial institution will go bust, triggering a financial panic, is probably lower now than in the past.  But the widely-dispersed losses that the owners of these synthetic products experience may impact consumer and business confidence.  Thus, market watchers will take their cues from the Conference Board's Consumer Confidence index reading, due for release on Sunday, and the Institute for Supply Management's Manufacturing index on Monday.