U.S. Mortgage Crisis Rivals S&L Meltdown

[EV_Ares]

Toll of Economic Shocks May Linger for Years;
A Global Credit Crunch
By GREG IP , MARK WHITEHOUSE and AARON LUCCHETTI
December 10, 2007; Page A1

The home has long been the bedrock asset of most American families. Now, its value has become the biggest question mark hanging over the global economy and financial system.

Over the past decade, Wall Street built a market for more than $2 trillion in securities sold globally and backed by loans to U.S. homeowners on two long-accepted beliefs and one newer one. The prevailing logic: The value of the American home would never fall nationwide, and people would almost always make their mortgage payments. The more recent twist: Packaging mortgage loans and turning them into securities would make the global economy more resilient if anything went wrong.


In a matter of months, though, much of the promise of the new financial architecture -- together with its underlying assumptions -- has proven to be a mirage. As house prices fall and homeowners default on mortgages at troubling rates, the pain has spread far and wide. An examination of the resulting crisis shows that it is comparable to some of the biggest financial disasters of the past half-century.

So far, the potential losses look manageable compared with the savings-and-loan crisis of the 1980s and the tech-stock crash of 2000-02. But the housing debacle could yet take years to work out, thanks to the sheer complexity of it. Until the mess is cleaned up, investors will remain jittery and banks will likely hold back on all kinds of lending -- a credit crunch that is already damping global growth and could tip the U.S. economy into recession.

The new financial system -- shifting risk from banks to securities markets -- has worked "pretty well" up until now, says former Federal Reserve Chairman Paul Volcker. "We're going to find out if it works well for a major-league crisis."

To ease the pain, the Federal Reserve has cut short-term interest rates twice and is expected to cut them further tomorrow. The Bush administration has also pressed for private-sector curative measures. First, it urged big banks to create a new entity to buy some mortgage-linked securities that don't have a ready market now. And a plan finalized last week calls for freezing interest payments on perhaps hundreds of thousands of qualifying homeowners whose mortgage notes are set to rise. Both ideas are controversial. They are hailed by some as well-conceived financial first aid and criticized by others as inadequate -- or an impediment to crisis resolution.

"There's no question that the Fed was remiss in the way they handled this. They are guided by a theory of the market which I think is false."
-- George Soros

"The key to whether this is really going to affect the economy in a major way is whether the banks become risk averse and credit tightens up to the that it will hurt the general economy." -- William Seidman

"This time you didn't have the same threat to the banking system you had in 1982." -- Paul Volcker

"It's been a good thing this country encourages home ownership… But maybe we've gone too far in that only so many people can comfortably own homes, and it became an excuse for extravagant lending." -- Robert Shiller

• Read more excerpts from interviews with Soros, Volcker, Seidman and Shiller.Veteran financiers see in the current episode a pattern consistent with classic financial manias: Investors' enthusiasm for an asset -- in this case U.S. houses -- drove up prices, attracted more capital and lifted prices to levels that preordained a fall.

Home prices rose sharply elsewhere, too, including in the United Kingdom, parts of continental Europe and Australia. "Old fogies like me expected the bust to come earlier than it did," says George Soros, the 77-year-old chairman of Soros Fund Management. "A lot of us got tired waiting for it."

entire article & interviews @ link of Wall Street Journal (subscription required):

http://online.wsj.com/article/SB119724657737318810.html?mod=hps_us_whats_news

[chiffon]

1. this is a great article.

i believe that we have yet to fully digest the full impact that this crisis will impact the economic and cultural influence upon the vast american society as we have known it.