So, with subprime mortgage losses and credit woes now the No. 1 topic in the markets, what does the former Goldman Sachs investment banker see next for the housing market and the U.S. economy?
Well, if you thought things were bad now, just wait. Think bank failures, recession, soaring default rates, home prices plunging by at least one-third and layoffs rippling across the economy. The unwinding could take five to seven years before the housing market hits bottom, he says.
As a former Wall Street insider, Mr. Talbott has a better appreciation than most for how large financial institutions operate. And what he senses now is a massive effort to conceal the extent of the toxic sludge buried beneath some of the biggest names in the business.
"Everybody is hiding and not disclosing losses," he says. "They're all winking and nodding at each other because they've all got this stuff on their books."
With 40 per cent of some banks' assets invested in residential mortgages, they won't be able to conceal their losses forever. Faced with rising defaults, banks are already pulling back on lending. The lack of credit, in turn, will exert a major drag on the economy, which for years has been fuelled by easy money. That's why Mr. Talbott says a recession in the next 12 to 18 months is a certainty.
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The subprime meltdown has been described as a liquidity squeeze, which makes it sound like a temporary problem that can be cured with an injection of cash. But the problem is far more serious, he says.
"Giving a bank more cash doesn't solve the problem. What they're sitting on is huge losses and they can't recognize those losses without endangering their entire book equity and threatening bankruptcy and threatening a run on the banks."
I don't know if things will get that bad, but it's a potential scenario. I suspect this very scenario that could happen is what is worrying many Americans.
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