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Lessons from the Mortgage Market Meltdown

Excellent paper on the mortgage crisis and its likely market impact:

We confirm the conventional view that the current problems in financial markets are concentrated in institutions that have exposure to mortgage securities. We use several methods to estimate the ultimate losses on these securities. Our best (very uncertain) guess is that the losses will total about $400 billion, with about half being borne by leveraged U.S. financial institutions. We then highlight the role of leverage and mark-to-market accounting in propagating this shock. This perspective implies an estimate of the eventual contraction in balance sheets of these institutions, which will include a substantial reduction in credit to businesses and households. We close by exploring the feedback from credit availability to the broader economy and provide new evidence that contractions in financial institutions balance sheets’ cause a reduction in real GDP growth.

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