Economists see trouble ahead, but no recession

Risky mortgages will rock the finances of lenders and homeowners across the nation before the crisis has passed, but they won't drag the U.S. economy into a recession.

That's the consensus of the Star Tribune's eight-member Board of Economists. None foresees a sharp economic downturn next year, despite hundreds of billions of dollars in losses in the housing and real estate markets.

"If you're going to sink this ship, with all the torpedoes that have been fired, you should be seeing more happening than you have," said Bill Melton, president of Melton Research in Edina.

Unlike the savings and loan crisis of the 1980s, the mortgage mess is not solely a U.S. problem. Investors holding the bag on troubled U.S. home loans can also be found from Norway to China and scores of nations in between, noted Dan Laufenberg, chief economist of Ameriprise Financial.

"It sounds like a problem for a wide range of investors around the world," Laufenberg said. "Is it going to be enough of a deal to derail the [U.S.] economy? I would argue no."

Because U.S. mortgage-linked securities were sold across the globe, some of the losses from the ongoing defaults will be felt well beyond the borders, Melton said.

"There are plenty of other dopes out there and we're not going to get stuck with it all," he said.

Paul Anton, chief economist at Wilder Research in St. Paul, was one of several economists who noted that many of the borrowers who took on mortgages in recent years did so with loans where they had to put up nothing in equity. That means that if they walk away from a mortgage, their credit rating will take a beating, but the only equity they give up is whatever phantom wealth they built up in the home before prices turned down.

"However, undeniably, its effect on many individual families, neighborhoods and even communities will be dramatic and profound," Anton said. "It commands our attention precisely because many of those families and neighborhoods are among the most economically vulnerable in our country."

A substantial share of the people who took out loans with little or no money down never should have been approved by their lenders, Laufenberg said.

He quoted a Los Angeles manager of rental property, who said, "'Easy credit made bad homeowners out of good renters.'"

"To some extent, I think that's close to the truth," Laufenberg added.

The danger of deficits

University of Minnesota economist Tim Kehoe said the government should resist the temptation to orchestrate a taxpayer-financed bailout of lenders or borrowers.

"We do not think that public policy should subsidize gamblers who lose at the casino, although we do worry about the mental health of those who might have an addiction to gambling," Kehoe said.

"We can think of recent events in the housing market as educational," he said. "Investment in housing is not a sure thing."

In Kehoe's view, hundreds of billions of at-risk home loans (estimates range from $100 billion to as much as $350 billion) represent a small problem compared with a national debt that's soared by trillions of dollars in recent years.

"The problems in the U.S. financial system have been caused mostly by large and persistent government deficits, not by the lost gambles on the housing market," he said. "The best way to restore the financial health of the U.S. economy is to eliminate these deficits, or at least reduce them, by some combination of tax increases and spending cuts."

But even in the absence of a recession, the subprime mortgage mess may lead to a host of unwelcome consequences.

Minnesota state economist Tom Stinson worries that fewer state residents will buy cars or make other big purchases, now that they have less home equity to draw on. An expected slowdown in spending and the job market lurks behind Stinson's latest estimate of a revenue shortfall of $373 million in the state budget for fiscal year 2008-09.

"It doesn't look to me that housing is at a bottom yet," Stinson said. "We've probably got at least nine months to go and probably more than that."

He pointed out that some credit analysts think the problems with bad loans, defaults, foreclosures and falling housing prices won't fully play out until 2010.

"If it takes another two years, we've got bigger problems than anyone can image at this point," Stinson said.

Art Rolnick, director of research at the Federal Reserve Bank of Minneapolis, said the nation's economy has shown resilience through many financial setbacks in recent years, including credit setbacks in Russia and Asia in the late 1990s.

He sees no reason to bail out homeowners or investors in the mortgage markets.

Buyers who signed on for exotic mortgages took a gamble that would have paid off if home prices kept climbing, as they did over the last decade, he said.

"People went in their with their eyes open. They were making bets," he said. "It's a little disingenuous to say, 'I didn't know what the deal was.'"

But Augsburg College economist Jeanne Boeh argued that too many buyers were unsophisticated, with little prospect of fully understanding the convoluted terms and conditions on the types of loans that lenders were pushing at the time as the most affordable way to own a home. Disclosure laws did not keep up with the sea of fine print embedded in loan agreements, she said.

"Who actually reads all of those 50 pages they're shoving at you?" Boeh asked.

She's also concerned that minorities will lose the foothold on the American dream, owning their own house, as a result of the pullback in mortgage lending.

"The good news is they were getting into homes," Boeh said. "But we've got to find some ways to keep them in their homes, so that family wealth will improve."

Mike Meyers • 612-673-1746