After testifying yesterday at the House Budget Committee on the state of the economy and fiscal stimulus, this morning I testified before the Senate Budget Committee on another key aspect ofthe currenteconomic downturn--the ongoing crisis in thehousing and financial markets.
Policymakers have responded to the turmoil with a set of unprecedented actions. Thus far, a systemic collapse of the financial system has not occurred, and conditions have improved noticeably in some financial markets. Nevertheless, according to some analysts, U.S. banks and thrift institutions could be facing more than $450 billion in additional estimated losses on their assetson top of the approximately $500 billion that has already been recognized. The scale of those losses suggests that many financial institutions and markets will remain deeply troubled for some time, which will keep borrowing exceptionally costly for many borrowers and thereby dampen spending by households and businesses.
Challenging conditions seem likely to persist for some time in the housing and mortgage markets as well. Housing sales remain weak, and construction activity continues to decline. With the housing markets large glut of vacant properties, the prices of homes are likely to fall considerably further, pushing the value of more borrowers homes below the value of their outstanding mortgages. As more of those underwater borrowers experience losses of income during the current recession, rates of delinquency and foreclosure on residential mortgage loans are likely to rise further.
In short, turmoil in the financial markets is likely to continue for some time, even with vigorous policy actions (and especially without them). A crucial and challenging question for policymakers is, What further actions can be taken to normalize the financial and housing markets so as to spur economic activity?
There are many options, none of them are perfect, and an effective policy probably requires a multifacetedapproach that uses a range of tools to address the different aspects of financial distress. The costs to federal taxpayers of actions to reduce mortgage foreclosures and improve financial conditions are highly uncertain and may be large, but the economic consequences of doing nothing may be even greater.
My written testimony (link here) provides information on interventions implemented by the government to date and alternative strategies going forward.
To deal with the faltering financial system, analysts have proposed several, possibly complementary, strategies: