Noted Economist Predicts That Investors Will Lose $1 Trillion in Mortgage-Backed Securities
If the predictions of Princeton economist Paul Krugman are correct, investors in mortgage-backed securities are facing a huge wave of additional losses. In a recent interview with Fortune, Krugman stated “I think there’ll be $1 trillion of losses on mortgage-backed securities showing up somewhere.” To date, Wall Street banks and others have reported only $232 billion in credit losses and asset writedowns, less than 25% of Krugman’s projected losses.
Krugman’s overall predictions for the American economy are even more gloomy. At the end of the current mortgage crisis, Krugman believes that there will be an average 25% decline in overall home prices and that approximately 20 million people will have negative equity in their homes (the homeowers will owe more on their homes than the homes are worth). Ultimately, he believes that the U.S. economy will suffer $6 to $7 trillion in capital losses in housing.
If Krugman is correct, the housing market will almost certainly remain unstable in the foreseeable future. If anywhere close to 20 million people have negative equity in their homes, it is reasonable to expect that many will be unable to pay their mortgage or will elect to simply walk away from their home rather than paying more for the home than it is worth. Of course, such a development would further flood an unstable housing market with additional homes to be sold. An additional influx of available homes for sale, in turn, would put additional downward pressure on home prices. As home prices decline further, additional people would be tempted to simply walk away from their homes. It could become a vicious circle.
Krugman’s prediction for mortgage-backed securities is equally dire. In Fortune, he stated “I look at the prices on subprime-backed securities. Even the AAA-rated tranche is selling for barely over 50 cents on the dollar, and the rest is essentially worthless, which amounts to a prediction that you’re going to get really very little on this stuff.” Since many Wall Street banks continue to “fair price” subprime securities at much higher levels than reported by Krugman, investors are likely facing far greater losses than they anticipate.
While some may suggest that Krugman’s views are extreme, it is interesting to note that the International Monetary Fund also has recently reported that financial losses stemming from the U.S. mortgage crisis may approach $1 trillion. The IMF’s report stated “the current turmoil is more than simply a liquidity event, reflecting deep-seated balance-sheet fragilities and weak capital bases which means its effects are likely to be broader, deeper and more protracted.” The report also warned of the likelihood of a “serious funding and confidence crisis that threatens to continue for a significant period.”
Investors holding mortgage-backed securities may want to fasten their seatbelts. It could be an awfully rough ride ahead.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 30 occasions. Page Perry’s attorneys are actively involved in representing individual and institutional investors regarding their subprime problems. For further information, please contact us.
