Goldman Sachs economists are forecasting $500 billion residential mortgage credit losses, a slowdown in the economy, and no monetary policy tightening in this year or 2009.
According to Goldman, many financial markets have made significant recoveries since the Bear Stearns and J.P. Morgan Chase marriage in March, but overall mortgage credit losses will still turn out to be larger than expectations. That is due to three reasons: the growing excess supply in the housing market, rapid falling home prices and much higher U.S. loan-to-value rations than previous downturns.
Goldman cautions there will be painful adjustments in the housing and credit markets and probably in the broader economy. Even if the shock is moderate, it can have large rippling effects if it reduces the equity capital of highly leveraged financial institutions that mark their balance sheets to market.
However, leveraged losses may have positive implications for the U.S. economic outlook. Less selling pressure or outright purchases of beaten-down assets will eventually raise asset prices and push down leverage. The resulting balance sheet relaxation will bring further asset purchases.
Still, Goldman warns that the downward slide of mortgage credit defaults has further to go and may soon shift away from the already ailing sub-prime mortgages to other residential mortgage debt, including prime mortgages.
That is why an economic slowdown is predicted and the Goldman doesn’t believe the Feds will tighten monetary policy any time soon.
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