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CNBC ON DIGG

Mortgage Crisis May Slash Lending Up to $2 Trillion

Companies:Goldman Sachs Group Inc

By: CNBC.com with wire services | 16 Nov 2007 | 10:48 AM ET

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The mortgage crisis could have a "dramatic" impact on the overall economy by forcing banks and other financial institutions to cut back their lending by as much as $2 trillion, a Goldman Sachs economist said.

In a report dated Nov. 15, Goldman's [GS Loading... () ] chief U.S. economist Jan Hatzius said a "back-of-the-envelope" estimate of credit losses on outstanding mortgages could reach around $400 billion.

But unlike stock market losses, which are typically absorbed by "long-only" investors, this mortgage-related hit is mostly borne by "leveraged investors"--those that depend on borrowed money--such as banks, broker-dealers, hedge funds and government-sponsored enterprises.

These losses could force these institutions to slash lending to keep capital ratios from falling.

"The macroeconomic consequences could be quite dramatic," Hatzius said in the note to clients. "If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion."

He said such a shock could produce a "substantial recession" if it occurred over one year, or a long period of sluggish growth if it occurred over two-to-four years.

"It's basically another downside risk to the macroeconomy at a time when the macroeconomy already isn't doing that well," Hatzius said in an interview on CNBC.

"I don't think there's a direct stock market implication from this," he added. "Perhaps with the exception that it does point to a slow-growth environment, significant risk of recession, and that's probably in an envrionment in which the cyclical sectors are going to underperform."

One of a number of caveats outlined in the report was that baseline economic forecasts may already include significant reductions in the pace of mortgage lending.

But the conclusion remained a gloomy one regardless. "The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized," he wrote.