Goldman Economist Sees $2 Trillion Subprime Impact on Lending

Jan Hatzius, chief economist at Goldman Sachs in New York, wrote an ominous report dated Thursday, saying the subprime-induced deterioration of global credit markets will force financial institutions to cut lending by $2 trillion, in effect bringing the risk of a "substantial recession" in the U.S. Hatzius said a back-of-the-envelope calculation of U.S. home foreclosure related losses could be as high as $400 billion for financial companies. Furthermore, the fallout may be amplified tenfold due to leverage, thus the $2 trillion figure based on a "conservative estimate" of losses of $200B. "The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized. It is easy to see how such a shock could produce a substantial recession [or] a long period of very sluggish growth," said Hatzius. The $2 trillion lending reduction is said to be equal to 7% of total U.S. household, corporate and government debt. Financial companies have already written down over $50B of subprime-related losses. At a banking conference on Thursday, Wells Fargo CEO John Stumpf commented, "We have not seen a nationwide decline in housing like this since the Great Depression." (Full story). Stumpf predicted more losses in 2008, but thinks the recovery will be sharp once the bottom is reached. Hatzius said the risk of recession is highest if the lending reduction happens over one year, but he still expects "very sluggish growth" in the event of a two to four year reduction.

Sources: Bloomberg
Commentary: Housing Market Tracker - Subprime Review • 10-Year Note's Thursday Drop Signals Recession Worry • Dow Theory Predicts Trouble Ahead for U.S. Economy
Stocks to watch: GS, MS, MER, LEH, C, BAC, JPM, WFC

Seeking Alpha's news briefs are combined into a pre-market summary called Wall Street Breakfast. Get Wall Street Breakfast by email -- it's free and takes only seconds to sign up.

Comments

[Donald Johnson:]

There's an interesting discussion at wsj.com's "Market Beat" blog.

Link is here:
blogs.wsj.com/marketbe.../

My reaction is that it's time to screen for debt-free, high cash flow companies with decent earnings records and prospects. Companies that are burning through cash and need to obtain or extend credit lines or go to the bond and commercial paper markets may be in big trouble.

2007 Nov 16 12:22 PM

[Sr. Pessimist:]

Debt-free is the only way to go now. If it's possible for one to pull it off, that is.

2007 Nov 17 09:16 AM

[Jordan Fogal:]

By Maya Roney

updated 7:08 p.m. CT, Wed., Aug. 22, 2007
She wasn't an investor. She didn't have a subprime mortgage. But when Jordan Fogal's house became uninhabitable, the 62-year-old grandmother says foreclosure became her best alternative.

Fogal's troubles began when she and her 72-year-old husband, Bob, moved to a new housing development near Houston in 2002. That first night in the new house, the dining room ceiling collapsed. Bob had pulled the plug in the Jacuzzi tub upstairs, and 100 gallons of water came crashing through the ceiling downstairs because the plumbing drains were not connected.

"That was a preview of coming attractions," Fogal says. Later, the roof and windows leaked, the yard flooded, the shower walls started bowing out, the floor in the kitchen started sinking, and mold began to grow all over the house. The smell was terrible, she recalls, and eventually Fogal's doctor ordered her to leave the house because of the dangerous mold levels. A construction company hired by the Fogals estimated that it would take $150,000 to repair everything. "I could afford my mortgage payment, but I couldn't afford $150,000 in repairs," says Fogal, who had a 30-year fixed-rate mortgage at the time. The home — appraised at $408,000 the day the couple bought it — ended up selling for $234,000 at a foreclosure auction.

Story continues below ↓
----------------------...
advertisement

----------------------...

"All of this time, I was begging the builder to fix these problems," Fogal recalls. But, she says, they only showed up to about 25% of the appointments she made. "That's absolute nonsense," says Tom Thibodeau, president of Tremont Homes and then-president of the Fogal home's builder, Tremont Custom Construction. "We tried everything we could to fix this house, and she refused it. She only wanted us to buy the house back."

The only original problem with the Fogals' house, Thibodeau says, was a roof leak that was neglected and led to a myriad of other problems. "She would like everyone to believe the house was foreclosed on because of the defect," he says. "But by neglect, she let the leak go and other problems manifested from the leak."

More than a subprime problem?
Fogal's case is not an isolated incident. Greg Cole, a homeowner in Georgia who runs a gripe site at georgiamoldhome.com, says he is on the brink of foreclosure after dealing with structural problems and leaks that have led to elevated mold levels. He, his wife, and his two children now take antibiotics every day, he says, because of the high level of mycotoxins — a toxin produced by fungi — in their blood. Elizabeth Dziedzic, a Realtor in Orange Park, Fla., says the deficiencies in her home make it impossible to sell for the amount it would take to pay off her mortgage balance. "There are only few events that are as devastating to a family as the loss of the family home to foreclosure," she says. "I guess this would be a price my family will pay for trying to achieve the American dream."

Foreclosures are up 93% from last year, according to Irvine, Calif.-based Web site RealtyTrac. At the same time, questions are arising as to whether construction quality suffered as homebuilders worked at lightning-fast speed to keep up with demand during the housing boom. It has become increasingly common for homeowners across the U.S. to share personal stories about defective construction through Web sites and blogs.

More from BusinessWeek.com
States With Highest Foreclosure Rates: July 2007
Healthiest Housing Markets
Where Rents Are Rising Fastest


"Everything you read says that the rise in foreclosure has to due with subprime lending," says Nancy Seats, president of Homeowners Against Deficient Dwellings, a nonprofit consumer protection group for homeowners dealing with defective construction. "But [defective construction] absolutely has something to due with the rise in foreclosures. There were absolutely investors that pushed up the price of housing, but there is no question that there are home buyers that were taken in and scammed big-time."

Why not just sue your builder when an irreparable problem arises? Homeowners usually don't have the right to. Most new-home sales contracts state that the customer must go through arbitration before they can even think about bringing their complaint to court.
Read the truth about the housing debacle.
Read more on the housing debacle: google my name Jordan Fogal

2007 Nov 18 12:58 AM