How Bad is the Mortgage Crisis Going to Get?

Paul Krugman is another leading economist who thinks things are going to get worse:

What started in subprime is likely to continue cascading into the markets and keep the economy down until 2010, economist Paul Krugman forecasts. Bottom line for homeowners: An average drop of 25%.

If the government could bail out Bear Stearns why can't they bail out the American people:

Fortune: By year-end, 15 million Americans could have mortgages worth more than the value of their homes. What happens then?

Krugman: Actually, I think home prices will fall enough for us to produce about 20 million people with negative equity. That's almost a quarter of U.S. homes. If home prices are rising, or if there's positive equity, you can refinance or sell. But if you have negative equity, you can end up being foreclosed on, and then some people will just find it to their advantage to walk away. We're probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there'll be $1 trillion of losses on mortgage-backed securities showing up somewhere.

What if it isn't enough:

Not since the 1930s. They didn't have the Fed funds target rate back then, but effectively we had a zero-interest-rate policy for a good part of the '30s. If the Fed responds this time with as much cutting as it did in the last two recessions, we get to zero. And then the problem is, What if that isn't enough? And there's a pretty good chance it won't be.

But what about the government stimulus plan:

I wasn't happy with it. Most of the money is given to people who are not much inclined to spend it, people who are not in financial difficulty. And therefore they will just put it in the bank or pay down credit card debt. I've been trying to make the case that since this thing is going to go on for a long time, effectiveness is more crucial than speed. I'm actually for public investment now - repairing bridges, building infrastructure. Normally people say if you try to do any public investment to stimulate the economy, the recession will be over before it can come online. But I don't think that's a problem this time.

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