Are Subprime Losses Being Exaggerated?

John Berry dedicates his Bloomberg column today to debunking exaggerated estimates of the magnitude of the subprime crisis. $300 billion, he asks? $400 billion? Pshaw.

A more realistic amount is probably half or less than those exaggerated projections -- say $150 billion. That's hardly chicken feed, though not nearly enough to sink the U.S. economy.
A loss of $150 billion would be less than 12 percent of the approximately $1.3 trillion in subprime mortgages outstanding.

Now Berry admits that the markets are valuing subprime securities as though total losses will exceed $300 billion, so he's basically saying that he's right and the markets are wrong. I'm generally suspicious when people say that, but Berry's math does make a certain amount of sense:

Most subprime borrowers aren't going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

Once you remember that a good $500 billion of that $1.3 trillion is in fixed-rate subprime mortgages with relatively low default rates, these kind of numbers do seem reasonable.

On the other hand, Berry assiduously avoids trying to tot up total losses from Alt-A and prime mortgages, not to mention the resulting losses in industries ranging from homebuilders to diswasher manufacturers. So while Tyler Cowen points to Berry's column as a reason why he's "not yet convinced by the economic pessimists," I don't find it nearly as compelling. The fact is that a lot of the USA's biggest and most important banks are in serious trouble, and when banks are in trouble, lending and growth invariably suffer.

And at the risk of sounding like a broken record, I'll repeat: no one is going to have a real handle on mortgage losses unless and until someone manages to get a handle on the percentage of mortgage loans which are non-recourse. If your house falls in value and you have a non-recourse mortgage, then it makes perfect economic sense for someone in a negative-equity situation to simply walk away – something known as "jingle mail". But given the amount of refinancing going on during the last few years of the mortgage boom, I suspect that the vast majority of mortgages are not non-recourse. (Refis are never non-recourse.)

If there are lots of middle-class homeowners out there suffering under the burden of enormous non-recourse mortgages which are worth more than their houses, we could easily find ourselves in a situation where total losses moved up into the $400 billion range. But that's a really big if.