Losses expected to double, while Fed remains under microscope
A previous version of this story misidentified the London School of Economics. The story has been corrected.
JACKSON HOLE, Wyo. (MarketWatch) -- The financial crisis has entered a new phase and will likely bring total credit losses above $1 trillion, according to a leading academic who has been studying the turmoil since its beginning a year ago.
Princeton University economics professor Hyun Song Shin says the subprime mortgage crisis has already cost financial institutions roughly $500 billion. Now, however, the problem has spread to the real economy, and losses on credit cards, consumer and business debt should match or exceed those from subprime mortgages and the like, he said.
"We'll see as much as the subprime losses again on the other side, at the very least," Shin in an interview Saturday with MarketWatch on the sidelines of the Federal Reserve's two-day annual economic seminar in Wyoming.
The International Monetary Fund has estimated that financial institutions will suffer a total $945 billion in credit losses. Shin said that remained a credible number, but was still probably on the low side.
"We are probably half way [through the financial turmoil], "Shin said. "The first stage is done -- we're at the second stage. ... The real issue is how much is how much the prime mortgage portfolio is going to be affected. That is going to depend on how far house prices will fall."
"This is something we don't have a really good handle on. I don't think anyone really knows," he said. "The IMF figures seem most credible, but if you believe others, it could be a lot worse."
But not everyone at the Fed seminar was downbeat on the U.S. economy's prospects.
Charles Calomiris, a professor at the Graduate School of Business at Columbia University, said perceptions of the housing market could turn out to be too pessimistic.
Once this becomes clear, bank stocks could bounce back, which would help them continue to recapitalize.
"Thus, it is still possible to envision a scenario under which the financial system avoids a sharp contraction in the supply of credit, although this is significantly less likely now that it was as recently as May," he wrote in a paper presented at the Fed's symposium.
Roasting the Fed
The Federal Reserve's actions to deal with the financial crisis were a major topic of discussion at the conference.
Since the start of the turmoil, the Fed has sought to pump cash into stressed financial markets. It has lowered its benchmark interest-rate target to 2.0% in a move seen as helping Wall Street's business of borrowing short-term funds to lend long. It also instituted a series of innovative cash auctions to primary dealers of government debt.
Those moves, however, have resulted in the central bank taking many troubled assets onto its balance sheet.
Several academics attending the seminar had heavy criticism of the Fed's actions.
Willem Buiter, a professor at the London School of Economics and a former member of the Bank of England's monetary policy committee, complained that the Fed had not demanded any quid pro quo from Wall Street in return for the enormous amount of liquidity it provided.
He said the Fed had blurred the distinction between what was in the public's interest and what was in Wall Street's interest, describing the recent performance as "not very good at all."
Buiter said there was an acute concern that the Fed was subsidizing banks by taking their "pig's ear" illiquid assets at "silk purse" prices.
He also said the Fed has been "pathologically secretive" about the terms on which financial support is made available to struggling institutions and counterparties.
Draghi sees tests ahead
Bank of Italy Governor Mario Draghi said the next few years will be difficult for monetary policymakers as banks repair their balance sheets.
"These adjustments will not be painless, and ensuring that they will take place in an orderly manner will pose substantial challenges for policymakers: Preserve price stability, while supporting growth, and continue injecting liquidity as needed by an industry that is still far from having resolved its problems, at a time of strong inflationary pressures and tightening credit conditions," he said in a speech at the conference.
Draghi said banks must also do their part to reduce uncertainties about their balance sheets.Greg Robb is a senior reporter for MarketWatch in Washington.