Let's figure this out. Subprime and Alt-A Mortgage Debt outstanding is something like $1.5 trillion. Let's say 20 percent default (double the default rate during the great depression). That is $300 billion in bad loans. If the loss that is 70 percent (probably an overestimate), that leaves $210 billion to clean up.
The S&L Crisis cost around $150 billion in present value terms (see http://www.erisk.com/Learning/CaseStudies/USSavingsLoanCrisis.asp). But the economy in 1995, which was pretty much when the clean-up ended, was half the size in nominal terms as it is now. So in the context of its economy, the subprime crisis is smaller than the S&L crisis, which was one of a number of events that led to a relatively mild, short-lived recession.
But there is an important difference. This crisis appears to have done serious reputational harm to rating agencies, which is turn means that lenders have less confidence about their ability to get repaid. This is turn means that non-residential lending is being affected by the subprime crisis. How much these spillovers matter will determine how much the crisis matters to the macroeconomy.
Professor John Taylor of Stanford presented a graph at Jackson Hole that suggested that the spillover from the subprime market to US credit markets was large, but that credit markets in other countries have to this point been immune from contagion. Let's hope this continues abroad, and that the non-subprime debt market in the US returns to normal reasonably soon.
Question about the S&L clean up: My assumption has been that the deposits at the failed S&Ls were FDIC insured so the federal government was already on the hook for the clean up. Is this correct?
ReplyDeleteIf so, there would appear to be a huge difference between the S&L cleanup and a sub-prime bailout. If the government was insuring deposits, there no additional moral hazard created in the clean up. Perhaps there is in offering deposit insurance but that decision would have been long past by the time the S&Ls failed.
A bailout of un-insured loans would reward and promote future reckless lending and borrowing behavior.
Oh, I am not saying the Government should bail out the investors. I was just making a point about the relative magnitude of the two crises.
ReplyDeleteRichard, do you have an opinion of how long it will take for this subprime mess to correct?
ReplyDeleteRhonda,
ReplyDeleteI think at least a year. But when the commercial mortgage market was dead in 1991, a famous analyst for Salomon Brothers said that the US would not need a new office building until 2000. Sam Zell, on the other hand, said "stay alive to 95," and was buying. Zell made billions; Salomon Brothers is now just the brand of a division of Citigroup.