1. Between $4 and $6 trillion in household wealth will be wiped out in the continuing real estate price deflation. About 2.2 million foreclosures will result and 10 million homeowners will be "upside down"--mortgage debt exceeding equity.
2. Financial loses will spread outside the subprime lending sector now expected to result in losses of $250 to $300 billion. This is so because about 60% of US mortgages originated between 2005 and 2007 had "toxic" features similar to subprime lending. Total mortgage credit loses could reach $400 billion or more according to Goldman Sachs. Securitization of toxic mortgage loans spreads the virus to international capital markets, thereby constricting liquidity on a global basis.
3.The worsening recession will lead to defaults in unsecured consumer loans--credit cards, auto loans and student loans--spreading the credit crunch to smaller banks and lenders. Less consumer credit results in less consumer spending, one of the main drivers of our national economy.
4. Monoline underwriters--insurance companies that specialize in bond default insurance--are experiencing severe losses, and the losses will be higher than the current $10-$15 billion private rescue package being put together by regulators. Inevitable credit downgrades of monoline companies will lead to losses in money market funds that invested in them.
5.The commercial real estate loan market will follow the subprime market into meltdown since the loan standards were just a reckless.
6. Some large regional or national banks exposed to toxic securitized loans will go under. Northern Rock in the UK has already been taken over by the government. Countrywide Financial in the US was bailed out with a $55 billion loan from the FHLB, a quasi-public system for funding mortgage lenders [3].
7.Because of banks' inability to shift their high leverage loans through securitization or syndication, they are stuck with billions of such loans on their books at well below par. Losses from reckless leveraged buyouts will mount.
8. A severe recession will result in a tsunami of corporate defaults--above 10% compared to the usual 3.8%
9. What has been referred to as "the shadow banking system" or non-bank financial institutions like hedge funds, money market funds, investment banks, and securitized investment vehicles are exposed to market and credit risks but without the ace card of access to the central banking window. As a result these institutions will go bankrupt as they are increasingly unable to refinance their risky investments.
10. The market will begin pricing a severe recession probably after the traditional year-end rally. Long margin calls will go off leading to another round of stock shorting, increasing its downward slide. The bear market will persist with the S&P500 down about 28%. Some hedge funds with long equity positions will fail.
11.The liquidity crunch will finally reach the derivatives markets. Inter-bank lending will also dry up despite massive infusions of capital by governments.
12. The vicious circle of defaults, write-downs, credit contraction, capital reduction and forced asset sales below fundamental values will feed further contraction and losses [4]. The trigger for the next round of pain and consternation will be the credit downgrading of monoline insurers and the ensuing drop in the equity markets. Sovereign wealth funds will be unable to counteract the huge losses due to the moves from off-balance sheet to on-balance sheet and from shadow banking to formal banking-- a process termed credit disintermediation. Sovereign wealth funds have already injected $80 billion into the international system so far. Panic will spread as a
number of large and systemically important institutions (like the two we have seen so far) become insolvent. A stock market crash could occur like the one in 1987 further exacerbating distress. As the Professor puts it, "In this meltdown scenario US and global financial markets will experience their most severe crisis in the last quarter of a century."[1]Besides lowering the discount rate, every other step the Fed is taking is an attempt to regain control of the financial system: Term Auction Facility (TAF);Term Security Lending Facility (TSLF);Primary Dealer Credit Facility (PDCF); approval from Congress to buy unlimited government stakes in Fannie Mae and Freddie Mac stocks and bonds; waiver for private equity firms to invest in banks; suspension of FASB accounting rules for a year.
[2]$5 trillion of Fannie and Freddie debit, whatever book keeping tricks are deployed, is now US government debt against which illiquid housing stock and derivatives are set against. Therefore the US debt has effectively now doubled
[3] According to a former Bush advisor, the FDIC is expecting 95 bank failures in 2008. Nine have failed so far. The latest is Silver State Bank of Nevada. John McCain's son, Andrew, sat on its board of directors until July. BankUnited Financial Corp. is also in trouble. BankUnited is Florida's largest bank with 85 branches in 13 counties with total assets of $14.2 billion. In the first three quarters of last year, it reaped a profit of $23.2 million. The first three quarters of 2008 showed $200 million in losses. A huge 58% of the bank's "assets" are option ARMs. Nonperforming loans have soared 1,964%. The bank's stock price is down 91%.
[3]Respected financial guru Richard Russell (Dow Theory Letters) has similar concerns: “...the markets are telling us to prepare for hard times, and a global spate of the worst deflation to be seen in generations ...sophisticated money is cashing out, raising cash, preparing for world deflation. This is why gold has been sinking...why stocks have been falling. What I see is a coming world deflation."