Straight from the horse's mouth

If you think the media has a tendency to exaggerate the threat the mortgage meltdown poses to the world economy (or at least be overly dramatic), here's the latest, straight from the horse's mouth. This is what members of the Federal Reserve's Open Market Committee were saying about the economy at their March 18 meeting, and what economists at the International Monetary Fund have to say about the global picture.

From the Fed meeting minutes:

"Stresses in financial markets had intensified noticeably since the January meeting. Several meeting participants noted that price discovery for mortgage-related financial assets had become increasingly difficult in an environment of declining house prices and considerable uncertainty as to the ultimate extent of such declines. With the magnitude and distribution of losses on mortgage assets quite unclear and many financial institutions experiencing significant balance sheet pressures, many lenders pulled back from risk taking -- notably by increasing collateral margins on secured lending -- and liquidity diminished in a number of financial markets. In these circumstances, many market participants were experiencing greater difficulties obtaining funding, and meeting participants regarded financial markets as unusually fragile. The new liquidity facilities recently introduced by the Federal Reserve would probably be helpful in bolstering market liquidity and promoting orderly market functioning, but even so, the ongoing strains were likely to raise the price and reduce the availability of credit to businesses and households. Evidence that an adverse feedback loop was under way, in which a restriction in credit availability prompts a deterioration in the economic outlook that, in turn, spurs additional tightening in credit conditions, was discussed. Several participants noted that the problems of declining asset values, credit losses, and strained financial market conditions could be quite persistent, restraining credit availability and thus economic activity for a time and having the potential subsequently to delay and damp economic recovery.

"Although some stabilization in housing markets was likely needed to help underpin an economic recovery in coming quarters, there was little indication that that process had yet begun. Elevated rates of foreclosures and large inventories of unsold property were likely to depress home prices for some time. Lower home prices would eventually buoy home buying, but in the meantime the prospect of continued price declines could lead potential homebuyers to defer purchases for a time, further damping housing activity and adding to downward pressure on home values. Participants noted that the trajectory of house prices was a major source of uncertainty in their economic outlook."

From the International Monetary Fund's latest Global Financial Stability Report:

"(F)alling U.S. housing prices and rising delinquencies on mortgage payments could lead to aggregate losses related to the residential mortgage market and related securities of about $565 billion, including the expected deterioration of prime loans. Adding other categories of loans originated and securities issued in the United States related to commercial real estate, the consumer credit market, and corporations increases aggregate potential losses to about $945 billion. These estimates, while based on imprecise information about exposures and valuation, suggest potential added stress on bank capital and further writedowns.

"Moreover, combined with losses to nonbank financial institutions, including monoline bond insurers, the danger is that there may be additional reverberations back to the banking system as the deleveraging continues. The risk of litigation over contract performance is also growing.

"Reduced capital buffers and uncertainty about the size and distribution of bank losses, combined with normal credit cycle dynamics, are likely to weigh heavily on household borrowing, business investment, and asset prices, in turn feeding back onto employment, output growth, and balance sheets. This dynamic has the potential to be more severe than in previous credit cycles, given the degree of securitization and leverage in the financial system. Thus, it is now clear that the current turmoil is more than simply a liquidity event, reflecting deep-seated balance sheet fragilities and weak capital bases, which means its effects are likely to be broader, deeper, and more protracted."

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