Are Subprime Losses Being Exaggerated?

John Berry dedicated his Bloomberg column yesterday to debunking exaggerated estimates of the magnitude of the subprime crisis. $300 billion, he asks? $400 billion? Pshaw.

A more realistic amount is probably half or less than those exaggerated projections -- say $150 billion. That's hardly chicken feed, though not nearly enough to sink the U.S. economy.
A loss of $150 billion would be less than 12 percent of the approximately $1.3 trillion in subprime mortgages outstanding.

Now Berry admits that the markets are valuing subprime securities as though total losses will exceed $300 billion, so he's basically saying that he's right and the markets are wrong. I'm generally suspicious when people say that, but Berry's math does make a certain amount of sense:

Most subprime borrowers aren't going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

Once you remember that a good $500 billion of that $1.3 trillion is in fixed-rate subprime mortgages with relatively low default rates, these kind of numbers do seem reasonable.

On the other hand, Berry assiduously avoids trying to tot up total losses from Alt-A and prime mortgages, not to mention the resulting losses in industries ranging from homebuilders to diswasher manufacturers. So while Tyler Cowen points to Berry's column as a reason why he's "not yet convinced by the economic pessimists," I don't find it nearly as compelling. The fact is that a lot of the USA's biggest and most important banks are in serious trouble, and when banks are in trouble, lending and growth invariably suffer.

And at the risk of sounding like a broken record, I'll repeat: no one is going to have a real handle on mortgage losses unless and until someone manages to get a handle on the percentage of mortgage loans which are non-recourse. If your house falls in value and you have a non-recourse mortgage, then it makes perfect economic sense for someone in a negative-equity situation to simply walk away – something known as "jingle mail". But given the amount of refinancing going on during the last few years of the mortgage boom, I suspect that the vast majority of mortgages are not non-recourse. (Refis are never non-recourse.)

If there are lots of middle-class homeowners out there suffering under the burden of enormous non-recourse mortgages which are worth more than their houses, we could easily find ourselves in a situation where total losses moved up into the $400 billion range. But that's a really big if.

Comments

[Malkiel]

It's already been pointed out in numerous articles elsewhere that Prime borrowers were taking out various types of ARM's to finance more house than they ought to (or to service other debt through refinancing) and are in the same dilemma now as the subprime borrowers, so talking about this as just a "subprime" problem is so September...the same analysts who took too long to figure out what the problem was are still clueless about its' actual dynamics...

2007 Dec 28 10:47 AM

[Solution]

The subprime problem is never as serious as wall street claimed, but someone is making a lot of money from it.
Here is why:
- Subprime problem can not exceed $300 billion, but 1% of total stock market is more then $100 billion. Will market lost more then 10%, i.e. $1 trillion because of $300 billion problem ?
- Wall street loves to cry to force Fed to inject free money. When institute "write off" the CDO's, those CDO's are off the book. But CDO's will never go to 0, because any mortgage is back up by a house. Institution either sell those under-table CDO's to Fed or sell cheap to bargain hunter. The money becomes executive's bonus. We really need IRS to investigate it. They are sucking investor's blood.

2007 Dec 28 10:55 AM

[Rhett]

Any subprime mortgage that an insolvent mortgagor walks away from is essentially non-recourse!

2007 Dec 28 04:50 PM

[Solution]

When insolvent mortgagor walks away, bank owns the house. Housing price ONLY down 10-15% !!! Even house is burned, there is property !!!

2007 Dec 29 11:19 AM

[sir percival]

blah blah blah.....gives the media the disaster of the month to sell print, then we will have to find the usual witches to burn, ie, greedy mortgage brokers, greedy wall street types..........followe... by the government (democrats) getting in front of cameras, holding congressional hearings about greedy republicans and then instituting bad laws that actually cause problems and damage our competitiveness and ability to conduct business.....then the drivebys will find a new assination or whatever and blah, blah, blah.

2007 Dec 29 11:52 AM

[ElisaS]

The sub-prime issue is a big problem and those that pooh-pooh it are obviously not having to deal with the reprocussions. There is indeed a large portion of this problem caused by the paniced knee jerk reaction that lending bodies have had.
However this still means that countries that have better structures and protections set up to avoid mis-use of this lending area are still feeling the pain. There are lenders that have been closing their doors because the wholesale backers do not have the funds to sell to them. I am sure you can imagine the onflow, loss of jobs, incomes, inability to pay debts, so on and so forth.

2007 Dec 29 07:08 PM