The subprime mortgage crisis in the US could lead to the opening up of a US$2 trillion black hole as banks and financiers stop lending money because of mounting losses, the leading Wall Street bank Goldman Sachs warned on Friday.
Goldman Sachs chief economist Jan Hatzius, who is regarded as an expert on the domestic housing market, warned that losses on outstanding loans could balloon to US$400 billion as borrowers struggled to repay debts.
That figure is well ahead of the US$50 billion or so losses already announced by major banks including Citigroup and Merrill Lynch, and well ahead of the Federal Reserve's own estimates. In July Fed Chairman Ben Bernanke estimated that losses on loans could be up to US$100 billion.
But the effects of the crisis are already being felt in other areas of the economy as banks tighten their lending criteria and speculative investment vehicles, which invested heavily in subprime mortgages, find it increasingly hard to borrow money on the short-term markets.
High-profile private equity deals have already collapsed or been delayed because of the difficulty of raising finance, including the sale of the US drinks business of Cadbury Schweppes and the possible buyout of Virgin Media.
This week Cerberus Capital Management backed out of the US$4 billion buyout of United Rentals.
Banks, meanwhile, have been tightening their lending criteria.
Nobel prize-winning former World Bank economist Joseph Stiglitz warned yesterday that "over the last five to six years our economy has been bolstered by the real estate sector. Americans have been taking money out of their houses to finance a consumption binge."
He said that with this avenue of funds closed off, the US faced a "very major slowdown, maybe recession."
Hatzius estimates in his note that the wider implications of the subprime mortgage crisis may be "quite dramatic."
"If leveraged investors see US$200 billion of the US$400 billion aggregate credit loss, they might need to scale back their lending by US$2 trillion," he said.
That is roughly equivalent to 7 percent of total US residential, corporate and government debt.