David Nason, New York correspondent | December 27, 2007
THE US economy could be heading into its blackest year since the Great Depression as estimates of losses from the housing slump and sub-prime mortgage implosion reach unprecedented levels.
The latest bank estimate of $US700 billion in losses made this week by Rob McAdie, the UK-based head of credit at Barclays Capital, is $US300 billion more than a headline-grabbing Golden Sachs estimate that jolted US markets just last month.
And it is light years from the $US50-100 billion in losses predicted by US Federal Reserve chairman Ben Bernanke to Congress in July. Expressed another way, the International Monetary Fund and World Bank say only 15 countries have a GDP higher than $US700 billion. Australia was 15th on both lists.
But even estimates of a $US700 billion sub-prime bloodbath may be conservative, with respected finance and economic blog sites like Calculated Risk predicting losses as high as $US1 trillion. The implications for global credit markets of losses of this magnitude would be horrendous, forcing banks and other institutions to slash lending by several trillion dollars.
Combined with the rising cost of oil, the US would be plunged into a recession, the severity of which would depend largely on the policy responses taken by the Fed and the White House to restore confidence and liquidity.
Writing in American Banker last week, Alfred DelliBovi, president and chief executive of the Federal Home Loan Bank of New York and a former deputy secretary of the US Department of Housing and Urban Development, said the lessons of the Great Depression could help avert disaster.
He said the Bush administration should look at the 1933 federal legislation that provided $US200 million to set up the Home Owners Loan Corp (HOLC) and gave it authority to issue $US2 billion of tax-exempt bonds. The funds were used by HOLC to buy delinquent home loans from lenders and refinance them directly with consumers on flexible terms.
HOLC offered to finance up to 80 per cent of a home's assessed value to a maximum of $US14,000, about $US225,000 in today's dollars.
By June 1935, HOLC had refinanced 20 per cent of all qualifying mortgages, saving about 800,000 home owners from foreclosure and stabilising the balance sheets of many lenders. HOLC liquidated itself in 1951 at a slight profit to the government.
"The HOLC success story should give policy makers cause to thoroughly consider reviving the model to deal with the current crisis in home finance," Mr DelliBovi wrote.
"Franklin D. Roosevelt said the broad interests of the nation require that special safeguards be thrown around home ownership as a guarantee of social and economic stability.
"Wouldn't it be a nice change if we could hear President Bush echo those words."
But the powers to intervene like this may not require the setting up of a new government instrument. As the credit crisis worsens, increasing attention is being focused on a 2004 paper by Fed legal division staffers David Small and Jim Clouse about the extent to which the central bank can lend money to individuals, partnerships and corporations (IPCs).
It concludes that the Fed's traditional constraints of conducting domestic open-market transactions only in US-backed or issued securities and making loans only to depository institutions can be relaxed in cases where banks become unwilling to provide credit.
When this occurs, the Fed is free to lend money to anybody it likes, so long as the circumstances are "exigent" and there is a vote in favour by five governors. "In making loans to IPCs, the Fed would be able to accept a wide variety of private sector credit instruments as collateral," the paper says.