Will the bursting of the US housing bubble bring down the economy?
After the US government bailed out the entire nation of Mexico in 1994 (Mexico effectively tried to default on its debts by formally devaluing the peso, which would have ruined several US banks), anything's possible.
The mortgage crisis has exposed a real vulnerability on Wall Street, because the banks packaged blocks of mortgages (including risky mortgages to subprime or otherwise overextended borrowers) and sold them as securities to investment firms, which in turn multiplied their profits severalfold through derivitives schemes.
That means the economic risk is actually significantly higher than the value of the mortgages at risk of default, and it inheres as much or even more in investment firms like Goldman Sachs and as in banks.
The House Financial Services Committee is currently holding hearings on the matter. It's in the interests of all the players - borrowers, banks, and investment firms - to prevent a wave of foreclosures, so the result will probably be something like what the US gave to Mexico: cash transfers (to the rich players, not the poor debtors), renegotiated terms, easier interest rates, and so on to keep those borrowers barely solvent and making payments for a few more years.
They'll probably get away with it, avoiding a short-term crisis but costing overextended borrowers more long-term hardship. It might even bring the US housing market into the clear.
A year or two ago I wouldn't have believed it was possible to recover from the biggest financial bubble in history, but too many powerful people have too much to lose in this brouhaha to let the bottom fall out.
However, salvaging the real estate bubble, like salvaging the dot com bubble before it, is kind of the macroeconomic equivalent of pushing down on badly applied wallpaper. The bubble will simply pop up somewhere else down the road.
With the US economy on such shaky foundations, OPEC countries starting to abandon the petrodollar system, and global oil production sliding into decline, loss of confidence in the dollar and the threat of hyperinflation will constrain the the government's capacity to spend its way out of the next crisis.
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