Economists are now worried that the escalating losses in the U.S. financial sector may soon exceed $1 trillion -- double the level of losses from the savings and loan calamity of the mid-1980s.
Layoffs on Wall Street are surging. Broker-dealer Lehman Brothers last week disclosed yet another round of firings, accounting for 5 percent of its work force. Earlier, Bear Stearns, Morgan Stanley and Merrill Lynch also furloughed financiers.
The crisis has gone global. Societe Generale’s London traders who sell bank debt are reported to have few to no customers, and not much to do.
Then came this weekend’s news that JPMorgan Chase, with help from the U.S. government, was buying up the remains of tattered rival Bear Stearns. The once-formidable bank lost nearly all of its equity value in just over a month.
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"The Fed-assisted fire sale of Bear Stearns over the weekend is probably not the last effort to stop a cascade of financial losses due to the collapse of the market for mortgage-backed securities,” says William Niskanen, a White House economic advisor for former President Reagan, now chairman of the libertarian think tank The Cato Institute in Washington, D.C.
"Although I have been critical of such bailouts in the past, this one was probably appropriate,” he said.
To put this all in perspective, the total losses if realized would be equal to 7 percent of the total annual economic output of the U.S. economy.
But the psychological impact is far, far greater, and signs of melancholy are everywhere in finance. Just last week, banks’ cost of borrowing reached the highest level this year.
Specialized markets that enable financial institutions to securitize mortgage loans are frozen solid.
Government-funded bailouts of once-venerable Wall Street firms are not the final solution to the financial problem, however.
"With the subprime mortgage crisis still spinning out of control, there are numerous factors within the real estate industry that need to be addressed to prevent further downslide,” says Thomas Inserra, former national chief appraiser of the FDIC and now CEO of a real estate technology firm Zaio.
"This especially includes more effort to prevent mortgage fraud,” he said.
Reform will address the "remaining structural issues” that are hobbling the financial industry, bank analyst Buddy Howard of Equity Research Services tells MoneyNews.
Chief among those changes will be a return to banks taking responsibility for the loans they write.
"Mortgage brokers have very little incentive to evaluate the risk of mortgages they make because they sell most of them in the form of mortgage-backed securities,” says Niskanen. New federal lending rules could restrain the practice.
Meanwhile, however, the Federal Reserve Bank’s easing of interest rates -- which have generated so much publicity in the financial media -- will have only a slight effect on the industry.
"This crisis is not something that can be unilaterally fixed through monetary policy,” says Howard.
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