DB: Housing May Drag U.S. Into Recession

The average American spends 3.5 cents of each dollar his home gains in value, according to the Federal Reserve.

If a homeowner spends 3.5 cents less for every dollar his home's value loses, Deutsche Bank researchers said a 20 percent decline in America's $21 trillion in home wealth would stanch consumer spending enough to shrink the economy for six months or more -- the definition of a recession.

In a conference called "The Subprime Mortgage Crisis and its Wake," head of securitization research Karen Weaver and head of asset-backed securities and collateralized-debt obligation research Anthony Thompson said the worst may be yet to come.

The housing industry is mired in a slump that has lasted more than two years. Too much building and an end to speculative buying have bloated the supply of unsold homes to more than 10 months.

Exacerbating the housing slump has been the exodus of money from the financing markets that sprouted to support the housing industry. This apparatus allowed mortgage lenders to issue home loans and sell them to investment banks, who in turn sold the debt to investors.

The result was the players in this industry all felt insulated from risk. The lenders only held the debt for as long as it took them to sell it. The banks only held the debt for as long as it took them to package it into bonds. And the investors who bought the bonds felt secure because the ratings agencies assigned the bonds good credit ratings.

Much of the financing for the housing boom came through the outpouring of cash into these debt markets, Weaver said.

Stung by decaying credit quality, demand for this type of debt shrank this year. This has forced banks to write off nearly $40 billion from their portfolios and forecast about $20 billion in further losses, Deutsche Bank estimated.

Earlier this week, Deutsche Bank analyst Mike Mayo estimated worldwide "subprime" losses, or losses on investments tied to bad mortgage debt, could reach $300 billion to $400 billion.

Embedded in this number is an estimate for $144 billion to $240 billion in "cash" losses, or losses on mortgage loans or investments secured by mortgages. Deutsche Bank also estimated $160 billion in "snythetic" losses, or losses on contracts whose value is determined by mortgage credit but not directly linked to the debt itself.

How much the banks lose hinges on how detrimental the interest rates adjusting higher on $400 billion in mortgage debt in the next two years will be, Weaver said. Delinquencies among subprime borrowers currently exceed 18 percent, and this could grow worse as borrowers are saddled with higher payments.