Another Opinion About the Condition of the Credit Markets

When the DJIA drops 300+ points in one day the news stories about bad news come out of the woodwork. None the less, this article from Market Watch is worth a read.

No one knows what is going to happen! However, there is sufficient bad news out there to make sure that everyone should be covering their risks. Were you out of the market?

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.

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.

"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.

As for the U.S. housing market, Zandi expects a lot more pain, but not a recession. Here I disagree. I expect a recession to start sometime in the 2nd half of 2007. The only thing keeping the economy out a recession is the consumer and they are beginning to struggle. Once the consumer pulls back on spending the unemployment rate will begin to increase as producers respond to weak demand. Once this happens the economy will slide into 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 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.