Economist: World Is One Hedge-fund Collapse Away From Crisis
Thu, Jul 26 2007, 20:16 GMTUPDATE: Economist: World Is One Hedge-fund Collapse
Away From Crisis
By Rex Nutting
WASHINGTON (Dow Jones) -- 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
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 market.
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.
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."
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 guide.
"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 late 1990s.
"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."
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
* 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 mortgages default.
* 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.
(END) Dow Jones Newswires
July 26, 2007 16:16 ET (20:16 GMT)