This will happen over time.  We have eliminated the implicit guarantee of these institutions, and made that guarantee explicit, effectively nationalizing them.  We have added $6 trillion of liabilities to the government’s balance sheet.  Of course, we have also added the GSE’s assets, and the net increase is the $200-300 billion I discussed earlier.

The US government is assuming a lot of new liabilities.  In addition to the cost of the GSE bailout, “We are facing a recession that will expand the deficit to 10% of the GDP.  This deficit increase will be funded through an issuance of government debt, which could lead to a downgrade of US Treasury securities." this includes the cost of the Bear Stearns bailout, the Frank-Dodd bill, the new lending facilities, a low Fed Funds rate, etc. 

We are facing a recession that will expand the deficit to 10% of the GDP.  This deficit increase will be funded through an issuance of government debt, which could lead to a downgrade of US Treasury securities. Over time this will push interest rates up.

Our deficit is now $140 billion, and in 2008 it is forecast to be $389 billion.  By 2009 it is forecast to be $490 billion, and I believe it will be significantly higher due to the recession.  [Note: this forecast of $490 billion represents 3.3% of GDP.]  When you add together the costs of the credit crisis, it is not surprising that people like Bill Gross of PIMCO forecast deficits of $800 billion. 

The US deficit is completely financed abroad, through sovereign wealth funds, central banks, and foreign investors buying US debt.  The fraction of US Treasuries held by non-US residents is now more than 50%.

The credit loss number is a moving target, and very little has been “fiscalized” (written-off).  In February of this year, my estimate was $1 trillion.  Then I said it would be $2 trillion.  People said I was crazy.  But then the IMF came out with their estimate of nearly $1 trillion, Goldman estimated $1.1 trillion, UBS estimated $1 trillion, Paulson estimated $1.3 trillion, and the hedge fund Bridgewater estimated $1.6 trillion.  So I was vindicated. 

The ultimate cost of the credit crisis depends on the degree of contraction within the economy.  I am confident that $1 trillion is the floor.

Most of the writedowns we have seen so far – approximately $300-350 billion - have been related to subprime mortgages.  We have yet to see the writedowns that will come from Alt-A, commercial, and real estate loans, credit card debt, student loans, municipal and corporate bonds, and CDS.  When you add all that up, it is not difficult to arrive at the estimates I have provided.

As many have said, this is not a subprime problem; it is a generalized and severe credit crisis.  We will see several hundred banks go bankrupt.

The next wave of writeoffs will come from homeowners walking away from their mortgages, when their mortgage exceeds the value of their house.  I estimate that the cost of these “walkaways” will be $300 to $400 billion, on top of the subprime losses already experienced.