WASHINGTON (MarketWatch) -- The problems in the U.S. subprime mortgage
market could spiral out of control into a global financial crisis, economist Mark
Zandi said Thursday.
With a "high level of angst" in the financial markets about
who will take the losses from more than $1 trillion in risky mortgages, we could
be just one hedge-fund collapse away from a global liquidity crisis, said Zandi,
chief economist for Moody's Economy.com.
A global meltdown is not likely, but the risks are growing, Zandi emphasized
in a conference call with reporters following the release of a new study on
subprime debt that concludes that the housing crisis could be deeper and last
longer than investors now believe. Read the latest data on home sales.
And it could spread. "Mounting mortgage delinquencies and defaults now
pose the most serious threat to the global financial system and economy,"
Zandi said in his report.
"If there is a fault line in the global financial system, it runs through
the U.S. housing and mortgage markets," he said.
Zandi's comments came as U.S. financial markets reeled from a growing credit
crunch, centered not in the subprime arena, but in the leveraged corporate debt
On Thursday, Tyco became the latest multinational company to pull a deal because
the buyers have fled. U.S. stock markets plunged Thursday, while U.S. Treasurys
benefited from a flight to quality. See Market Snapshot.
Treasury Secretary Henry Paulson, an old Wall Street hand himself, tried to
reassure markets with a mid-afternoon televised pep talk. Lenders and borrowers
should exercise more "discipline," he said, and he repeated his view
that any problems in the subprime market would be "largely contained."
But Zandi and others say the problems are only beginning.
In a note to clients on Wednesday, Goldman Sachs chief economist Jan Hatzius
said the housing correction could be less than half over, if history is any
"The dramatic deterioration in the mortgage market suggests at least
the possibility that the credit crunch in the mortgage finance industry could
become as bad as in the bad old days of the 1970s and 1980s," Hatzius wrote.
Zandi used another historical comparison: the Asian financial crisis of the
"Unlike the financial crisis of a decade ago, however, global capital
would likely flow away from U.S. markets, not to them, as the genesis for the
crisis lies within the U.S. financial system."
After Bear Stearns was forced to write off the value of two large hedge funds
that had invested heavily in securities backed by subprime debt, it could take
just one more "Bear-like event" for the financial system to freeze
up, "If there's another major hedge fund that does stumble, that could
elicit a crisis of confidence and a global shock," Zandi said. The potential
"is quite high," he said. He gave it a one-in-five chance.
Zandi said global financial conditions have been supported by strong growth
and substantial liquidity, supercharged by "unprecedented risk tolerance."
But that's changing. Global liquidity is drying up, with central banks tightening.
And risk is being re-priced.
"The credit window is now closed," wrote strategist Barry Ritholtz
in his blog.
As for the U.S. housing market, Zandi expects a lot more pain, but not a recession.
Here are some highlights of his forecast, based on a study using anonymous
data collected by consumer credit agency Equifax:
- Home prices will fall 10% from the peak nationally, more in the bubble regions
in California, Florida, Nevada, Arizona and Washington, D.C.
- Home sales could bottom later this year, home construction could bottom
early next year, and house prices could bottom late next year. It'll be 2010
before the housing market could be termed "normal."
- About 17% of total mortgage debt is at risk, totaling about $2.5 trillion
in subprime, Alt-A and jumbo debt. About $1.4 trillion is at serious risk
of default. Investors will lose about $113 billion as $460 billion worth of
- About 20% of the subprime loans written in the last half of 2006 will fail,
with the peak of the defaults not coming until 2011. A "significant number"
of these borrowers never made a single payment.
- More than 2.5 million first mortgages will default this year and next year.
Subprime borrowers will experience significant financial distress.
- The U.S. economy will grow less than 3% annualized through the middle of
2009. A healthy job market should prevent a recession, although the jobless
rate will likely rise to 5% from 4.5% by the end of the year.
- Consumer spending has already slowed and will slow further.
Rex Nutting is Washington bureau chief of MarketWatch.
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