Subprime crisis could pack political punch

CHICAGO (Reuters) - Sound familiar? A financial crisis that has rattled Wall Street is gathering steam in Washington and could pile more pressure on an Iraq-weary President Bush.

President George W. Bush waves as he walks on the South Lawn of the White House upon his return to Washington March 14, 2007. REUTERS/Yuri Gripas

No, it’s not the savings and loan crisis that left Republicans and Democrats trading blame for the economic fallout that contributed to George H.W. Bush’s defeat in the 1992 election.

This time the turmoil surrounds unconventional mortgages that threaten to force millions of Americans out of their homes, giving Democrats more ammunition to fire at Republican President George W. Bush.

Many economists say the parallels between the S&L scandal of the 1980s and today’s subprime situation largely begin and end with the father-son connection in the White House, and the housing-related problems are unlikely to trigger widespread bank failures provided the economy stays healthy.

“If everything goes south, it would weigh on Bush the Junior for sure,” said Austan Goolsbee, an economics professor at the University of Chicago Business School.

But Goolsbee noted a critical difference between the thrift crisis and the current subprime mess. With the S&L debacle, the government played a big role in creating the problem because it deregulated the banks while keeping government guarantees in place to bail out those in trouble, he said.

“The S&Ls could take risky bets. If they lost, they knew that they could dump it on the government,” Goolsbee said. “That encouraged them to take the most insane risks.”

This time, the problems stem from unconventional practices by mostly nonbank lenders, such as offering 100-percent financing, interest-only loans, and teaser rates that start low but then spike. Mortgage brokers made big profits off such deals, and there were few complaints until the housing market cooled and borrowers ran into trouble.

The Center for Responsible Lending estimates that one in five subprime mortgages written in 2005 and 2006 will end in foreclosure. Research firm RealtyTrac predicts that 1.5 million homeowners will face foreclosure this year.


With the November 2008 election cycle already in full swing, leading Democrats such as presidential candidate Sen. Hillary Rodham Clinton of New York have jumped on the issue.

Clinton accused the Bush administration on Thursday of overlooking problems in the subprime mortgage market, and said Republicans were too focused on providing tax cuts for the rich to pay attention to the growing housing problems.

Most economists, including Federal Reserve Chairman Ben Bernanke, argue that the housing slowdown is well contained and unlikely to sink the broader economy.

However, talk of a possible recession has picked up after Bernanke’s predecessor, Alan Greenspan, said chances of a downturn could be as high as one-in-three.

“The economy is still pretty strong. We haven’t gone into recession. The job market is still relatively robust. Interest rates haven’t gone up,” Goolsbee said. “If Alan Greenspan is right and we might be teetering near recession, it’s going to get horrible,” he added, saying a downturn could spark a full-blown banking crisis.

Greenspan said on Thursday there was a risk that rising defaults in subprime mortgage markets could spill over into other economic sectors, but said weakness in the housing market would be quickly resolved if home prices rose by 10 percent.

Nouriel Roubini, a professor at New York University and head of Roubini Global Economics, is one of the few economists who has been predicting a recession this year. He contends that subprime loans are only the tip of the iceberg.

“We’re going to have a severe banking problem that at some point is going to lead to a government bailout like the S&L scandal,” he said. “The cost to the U.S. taxpayers may end up being much larger than the $200 billion we spent bailing out the S&Ls.”

Roubini argues that, like the S&L scandal, lax government oversight is at least partly to blame for the subprime crisis.

“We let mortgage lenders do anything they wanted for years,” he said. “Regulators were asleep at the wheel.”

If the economy slips into recession, as Roubini expects will happen by summer, “then you have a systemic banking crisis like we haven’t had since the 1930s. The cost could be as high as $1 trillion,” he said.