NEW YORK (Reuters) - Goldman Sachs economists expect a total of $500 billion in residential mortgage credit losses, a renewed slowdown in economic activity after the near-term boost from fiscal stimulus, and no monetary policy tightening in 2008 or 2009, according to a research note from the firm.
Despite a setback in recent days, many financial market indicators have recovered substantially since the Bear Stearns/JPMorgan Chase & Co deal in mid-March, Goldman Sachs chief U.S. economist Jan Hatzius said.
Still, “we think that overall mortgage credit losses will end up being larger than generally believed,” Hatzius said.
“Excess supply in the housing market is still growing; home prices are already falling at rates that are very rapid by the standards of previous housing downturns around the world; and U.S. loan-to-value ratios are much higher than in those previous downturns,” he said.
“Ultimately, a painful adjustment needs to take place, certainly in the housing and credit markets and likely in the broader economy as well,” Hatzius said.
Even if the shock is moderate, it can have large multiplier effects if it reduces the equity capital of highly leveraged financial institutions that mark their balance sheets to market, he said.
Although the leveraged losses story sounds dire, its implications for the U.S. economic outlook are actually somewhat encouraging at present, Hatzius said.
Reduced selling pressure or outright purchases of beaten-down assets will eventually support asset prices, this will push down leverage, and the resulting balance sheet relaxation will facilitate further asset purchases, he said.
“This means that good news can continue to feed on itself,” he said, with “positive spillover effects on sentiment and activity in the broader economy.”
Still, the increase in mortgage credit defaults is large and has further to go and the “locus of pain” tied to losses related to further mortgage credit defaults is likely to shift away from subprime mortgages, where the markets are already discounting very large losses, to other residential mortgage debt, including prime mortgages, Hatzius said.
“This is one reason why we expect a renewed slowdown in economic activity after the stimulus-fueled bounce in mid- to late 2008,” Hatzius said.
That “makes us fairly confident that Fed officials will not start tightening policy at that time, as markets now seem to believe,” he said. “If anything, they may come under pressure to ease further, though at present this is not our base case.”
Editing by James Dalgleish