Subprime mortgage delinquencies and the credit crunch will trigger $400 billion in losses to the U.S. financial system and knock 1.3 percentage points from growth in 2008, according to a paper released Friday by four leading economists.
"While these estimates have many caveats, they still suggest that the feedback from the financial market turmoil to the real economy could be substantial," a quartet of academic
and Wall Street economists wrote in a paper to be presented at a monetary policy forum organized by the business schools of the University of Chicago and Brandeis University.
The economists said half of the $400 billion in losses will be borne by leveraged U.S. financial institutions, many of which took risky bets on subprime mortgage securities that turned sour when delinquencies rose.
The paper's authors -- David Greenlaw of Morgan Stanley, Jan Hatzius of Goldman Sachs, Anil Kashyap of the University of Chicago, and Hyun Song Shin of Princeton University -- said
that as hard-hit financial institutions shore up their capital, they will retreat from extending credit to the tune of about $910 billion.
A drying up of credit availability will cause businesses and consumers to pull back from spending and investing, the authors say.
Panelists and participants in the forum include Fed Governor Frederic Mishkin, Boston Fed President Eric Rosengren, Chicago Fed President Charles Evans, St. Louis Fed President
William Poole, and Bank of England Executive Director Paul Tucker.
The paper comes shortly after the Fed itself presented a gloomy outlook for the economy in months to come as it struggles with a deep housing slump, tighter credit and financial market turbulence. Fed Chairman Ben Bernanke, whose own academic work includes extensive study of how financial market malfunction hurts the broader economy, told Congress this week he expects sluggish growth in coming quarters.
The economy expanded at a meager 0.6 percent in the final months of 2007, and some analysts forecast recession this year. The Fed's forecast is for growth between 1.3 percent and 2 percent, and Bernanke has said the Fed is not forecasting recession.
Meanwhile, the economists said in their paper on Friday that stress to financial markets in recent months has surpassed anything in the past 18 years, including the failure of the
Long Term Capital Management fund and the 1990-91 U.S. savings and loan crisis, citing elevated risk premiums being charged in money markets.
Adding to the dour projection, the economists said that housing markets will be harder pressed to recover in the current episode than after past housing busts. This is because credit standards were more lax during the most recent boom, and because so many adjustable rate mortgages are due to reset at higher levels.