John Berry dedicates his
Bloomberg column today to debunking exaggerated estimates of
the magnitude of the subprime crisis. $300 billion, he asks? $400
billion? Pshaw.
A more realistic amount
is probably half or less than those exaggerated projections — say $150
billion. That’s hardly chicken feed, though not nearly enough to sink
the U.S. economy.
A loss of $150 billion would
be less than 12 percent of the approximately $1.3 trillion in subprime
mortgages outstanding.
Now Berry admits that the markets are valuing subprime
securities as though total losses will exceed $300 billion, so he’s
basically saying that he’s right and the markets are wrong. I’m
generally suspicious when people say that, but Berry’s math does make a
certain amount of sense:
Most subprime borrowers aren’t going to default. Suppose
even one in four does and lenders recover somewhat more than half the
mortgage amount. A fourth of $1.3 trillion in subprime mortgages is
$325 billion, and a 55 percent recovery would mean a loss of about $145
billion.
Once you remember that a good $500 billion of that $1.3
trillion is in fixed-rate subprime mortgages with relatively low
default rates, these kind of numbers do seem reasonable.
On the other hand, Berry assiduously avoids trying to tot up
total losses from Alt-A and prime mortgages, not to mention the
resulting losses in industries ranging from homebuilders to diswasher
manufacturers. So while Tyler Cowen points
to Berry’s column as a reason why he’s “not yet convinced by the
economic pessimists,” I don’t find it nearly as compelling. The fact is
that a lot of the USA’s biggest and most important banks are
in serious trouble, and when banks are in trouble, lending
and growth invariably suffer.
And at the risk of sounding like a broken record, I’ll repeat:
no one is going to have a real handle on mortgage losses unless and
until someone manages to get a handle on the percentage of mortgage
loans which are non-recourse. If your house falls in value and you have
a non-recourse mortgage, then it makes perfect economic sense for
someone in a negative-equity situation to simply walk away –
something known as “jingle
mail“. But given the amount of refinancing going on during
the last few years of the mortgage boom, I suspect that the vast
majority of mortgages are not non-recourse.
(Refis are never non-recourse.)
If there are lots of middle-class homeowners out there
suffering under the burden of enormous non-recourse mortgages which are
worth more than their houses, we could easily find ourselves in a
situation where total losses moved up into the $400 billion range. But
that’s a really big if.