U.S. housing crisis reverberates around the globe

Subprime loans flourished at the end of the U.S. housing boom as lenders offered mortgages to people with shaky credit in an effort to cash in on surging prices.

These loans were packaged into securities that were sold to investors around the world, with little regard to what would happen when low “teaser” rates were reset to increase payments from homeowners.

When a wave of defaults began to hit, U.S. and global banks began to see billions of dollars in losses on their balance sheets. The lenders had to tighten credit, crimping consumer and business spending and threatening the overall economy.

Goldman Sachs economist Jan Hatzius. says his “back-of-the-envelope calculation” now suggests “losses of around 400 billion dollars” for global banks and investors.

Although this may not seem large in the overall economy, Hatzius. says the effect is magnified because banks need to scale back their lending to keep capital ratios intact after accounting for the losses. As a result, he said lending could be cut by two trillion dollars.

“Even if this occurs gradually, and even if there are some offsets from reduced credit demand and increased lending by other sectors, the drag on economic activity could be substantial,” said Hatzius. in a note to clients.

Adding to the woes from housing are near-record energy prices and a weak dollar that could fuel inflation and hurt business confidence. Some say a recession is a possible scenario.

“The U.S. is on the precipice of its first consumer recession since 1991, which was the last time the market suffered from a confluence of high energy prices, weakening employment conditions, real estate deflation and tightening credit,” said David Rosenberg, Merrill Lynch’s chief North American economist.

While debate is raging on whether the U.S. economy will avert recession, another question is how much a U.S. slowdown will affect the global economy.

Some experts say there has been a “decoupling,” meaning the rest of the world is less dependent on the United States. But any slump in the U.S. is still likely to have a global impact.

“We think 2008 will be the ‘year of recoupling,’” says Peter Berezin, a Goldman Sachs global economist.

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