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US crisis could spill into 2010

By BS Reporter in Kolkata
December 05, 2008 10:14 IST
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The subprime crisis and the ongoing financial crisis and the economic downturn may get worse before it gets any better in the American economy and the effect might as well spill over to 2010, warned American economist James R Barth.

Speaking at the Bengal Chamber of Commerce & Industry (BCCI) on the American subprime and financial meltdown, Barth said, "It is most unlikely that the situation is going to get better any soon before middle or end of next year and might as well spill over to 2010."

However, he refused to term the ongoing crisis a 'depression' since the recession which started from December 2007 was not as bad as it was expected to be, he claimed.

Barth said the crisis was caused by excessive leveraging by investment banks, blind trust on credit rating agencies which failed to distinguish between the sub-prime and prime borrowers, hybrid or adjustible mortgage loans allowing people with shaky credit records to borrow with no income verification whatsoever and securitisation of mortgages into packages to disguise problems.

Quoting Federal Reserve statistics, Barth said total value of housing stock was $ 19.3 trillion of which around $10.6 trillion was mortgage debt and the remaining $8.7 trillion equity in housing stock. Of the mortgage debt of $19.3 trillion, 8.4 percent was contributed by sub-prime borrowers and the remaining 91.6 per cent prime borrowers, while 58 per cent of the total mortgage debt was securitized and 42 per cent is non-securitized.

Barth said in United States, of the 80 million houses, 27 million were paid for, but 53 million had mortgages of whom 48 million were paying on time and only five million were making late payments. Half of this five million faced foreclosures.

The US Fed's decision to lower the interest rate too much for too long could lead to hyper inflation, a credit boom and a home price bubble which peaked in 2006, causing home prices in California and nationally to reach record highs, he added. He said around 40 per cent of subprime mortgages were not securitized by the big three of Freddie Mac, Fanny Mae and Jennie Mae but private-label securitizers who were not backed by US government.

Many mortgages were backed by securities, collaterized against securities and sold to investors across, and so were good investments only as long as the housing bubble was on. With collapse of the housing market and home prices, the whole system crumbled.

"US was doing nothing but just exporting losses all across the world," admitted Barth.

The total amount committed by the US government was $7.5 trillion and Fed would have to continue to inject liquidity into the system besides framing and enforcing a proper regulatory structure.

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