US Housing Crisis Reverberates Worldwide

Source : The Straits Times, Dec 19, 2007

Banks, investors could lose hundreds of billions as lending is scaled back drastically

WASHINGTON - FEW people knew at the start of this year the meaning of 'sub- prime' home loans or how they might affect the United States and global economies.

Today, worries are growing that the crisis that began with mortgage failures and spread to banks and brokerages may push the US economy into a downturn and put the entire global economy at risk.

Sub-prime loans flourished at the end of the US housing boom, as lenders offered mortgages to people with shaky credit in an effort to cash in on surging prices.

These loans were packaged into securities that were sold to investors around the world, with little regard to what would happen when low 'teaser' rates were reset to increase payments from home owners.

When a wave of defaults began to hit, US and global banks began to see billions of dollars in losses on their balance sheets. The lenders had to tighten credit, crimping consumer and business spending and threatening the overall economy.

Goldman Sachs economist Jan Hatzius says his 'back-of-the-envelope calculation' now suggests 'losses of around US$400 billion (S$582 billion)' for global banks and investors.

Although this may not seem large in the overall economy, he says the effect is magnified because banks need to scale back their lending to keep capital ratios intact after accounting for the losses. As a result, he says, lending could be cut by US$2 trillion.

'Even if this occurs gradually, and even if there are some offsets from reduced credit demand and increased lending by other sectors, the drag on economic activity could be substantial,' said Mr Hatzius in a note to clients.

Adding to the woes from housing are near-record energy prices and a weak US dollar that could fuel inflation and hurt business confidence. Some experts say a recession is a possible scenario.

'The US is on the precipice of its first consumer recession since 1991, which was the last time the market suffered from a confluence of high energy prices, weakening employment conditions, real estate deflation and tightening credit,' said Mr David Rosenberg, Merrill Lynch's chief North American economist.

While debate is raging on whether the US economy will avert a recession, another question is how much a slowdown will affect the global economy.

Some experts say there has been a 'decoupling', meaning the rest of the world is less dependent on the US. But any slump in the US is still likely to have a global impact.

'We think 2008 will be the year of recoupling,' said Mr Peter Berezin, a Goldman Sachs global economist.

'The mortgage meltdown in the US has clearly affected global financial markets,' he noted, adding that 'the weakness in the US housing market is starting to raise concerns that the global housing market may suffer a similar fate'.

Mr Paul Sheard, an economist at Lehman Brothers, is guarded, saying: '2008 is shaping up to be more challenging for the global economy than 2007 was. We expect growth to be lower.'

'If the US slows and other developed economies follow, these economies will not be able to escape knock-on effects via the trade channel in particular, but also via financial and confidence channels,' he said.

'We expect growth in Asia ex-Japan and in emerging markets to decelerate but to maintain a healthy clip, given strong growth momentum, particularly in China and India.'

In a more upbeat outlook, Societe Generale global economist Brian Hilliard in London says the worst may be over for the US and global economies, even if the impact from housing and credit was bigger than initially expected.

'We remain more optimistic about the ability of the world economy to withstand the shock from this liquidity event,' he said.

'Our forecast for US growth of 2.6 per cent in 2008 is higher than consensus. The Fed has signalled that is less keen to make further rate cuts because the real economy looks in relatively good shape but it is flexible.'

AGENCE FRANCE-PRESSE