How Big Is The Mortgage Meltdown?

For the first time estimates are beginning to suggest the true size of the mortgage meltdown. The newest numbers are so large they dwarf the latest federal deficit, a total of $163 billion.

It was just last May that the mortgage meltdown seemed contained. John Robbins, Chairman of the Mortgage Bankers Association, told reporters at the National Press Club that “as we can clearly see, this is not a macro-economic event. No seismic financial occurrence is about to overwhelm the U.S. economy.”

Now, however, opinions have begun to change.

“The mortgage black hole is, I think, worse than anyone thought,” says Tony James, president and CEO the Blackstone Group, a private equity and investment management firm.

Banks & Brokerages
Just in the subprime mortgage sector, David Hilder, an equity analyst with Bear Stearns, says “total losses could be between $150 billion and $250 billion, reflecting a range of write-downs on an estimated total sub-prime mortgage exposure of roughly $2 trillion. At the low end, our estimate would reflect an ultimate foreclosure rate of 25 percent and losses of 30 percent on those mortgages; at the high end, it reflects a foreclosure rate of 30 percent and average losses of 40 percent.”

Mike Mayo, an analyst with Deutsche Bank Securities, points to even bigger numbers. He estimates that there could be subprime losses of $60 billion to $70 billion for banks and brokerages by year-end. Mayo explains that write-downs valued at $43.9 billion have already been reported, that banks and brokerage holdings may have total subprime losses ranging between $100 billion to $130 billion, and that subprime losses in general could total from $300 billion to $400 billion.

It is, says Blackstone’s Tom James, “deeper, darker, scarier than what the banks thought.”

Bigger Still
Although Mayo expects banks and brokerages to absorb about one-third of all subprime losses, the potential for damage from the mortgage meltdown is far broader.

“Even a $400 billion loss does not look all that large compared to the vast size of the US financial markets, and one sometimes hears that it is just equivalent to one bad day in the stock market,” says Jan Hatzius, an analyst with Goldman Sachs. “But this analogy is wrong. There is a big difference between stock market losses, which are mostly borne by long-only investors, and mortgage credit losses, which are mostly borne by leveraged investors such as banks, broker-dealers, hedge funds, and government-sponsored enterprises.”

Hatzius says that each “$1 mortgage credit loss could result in a reduction in lending by significantly more than $10.”

What does this mean to the mortgage marketplace?

In a November 15th commentary, Hatzius explained that “these facts suggest the potential for a very sizable hit to the supply of credit. Suppose that leveraged financial institutions suffer $200 billion out of the total $400 billion mortgage credit loss, which is probably a conservative estimate given the distribution of mortgage assets according to the flow of funds. Suppose also that these leveraged investors react by reducing their asset holdings by 10 times the hit to their capital, which again is a conservative estimate given the leverage and behavior especially of the broker-dealer community. Under these assumptions, the supply of credit by leveraged institutions would fall by $2 trillion, all else equal.”

With a typical existing home priced at $218,200 this year according to the National Association of Realtors, $2 trillion would be enough to finance 9,165,902 houses with nothing down. These are big numbers given that NAR projects a total of 5.67 million existing home sales in 2007.

“During the past year the real estate slowdown has been fueled by a surplus of distressed homes pushing down local real estate values,” says James J. Saccacio, chairman and chief executive officer of RealtyTrac, the nation’s largest marketplace for foreclosure properties. “If we also have a credit squeeze it’s not that there would be no loans, instead interest rates would be forced higher and loans would be more difficult to get. The result would be lowered real estate demand, a further reduction of home values and fewer opportunities to refinance existing loans. These are results no one should welcome.”
Columnist Peter G. Miller is the author of The Common-Sense Mortgage and is syndicated in more than 100 newspapers.

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