When John Talbott's controversial book, The Coming Crash in the Housing Market, hit store shelves in 2003, the real estate industry - and everyone else who stood to profit from the dizzying rise in U.S. home prices - gave it a hostile reception.
"Real estate agents didn't like it, mortgage brokers didn't like it, commercial bankers didn't like it, Wall Street didn't like it," he recalls.
"Even when I went on the talk-show circuit, you could tell the animosity in the anchor who was interviewing me because he had a big home and a big mortgage and didn't want anybody suggesting prices might go down."
Four years later, with the U.S. housing collapse unfolding exactly as he predicted, Mr. Talbott is enjoying a measure of vindication as the guy who first warned about the disastrous cocktail of adjustable-rate mortgages, reckless lending practices and lax oversight.
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.
Banks most at risk for failure are those with a concentration of residential mortgages in Florida, California and New York, where prices rose the steepest and will fall hardest, he says. But even some of the biggest U.S. banks could be at risk, he says. Canadian banks are, thankfully, not as exposed to the problems.
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."
What should investors do? Mr. Talbott, who owns no stocks or residential real estate, is a big fan of cash. The returns aren't great, but they're a lot better than losing 10 or 20 per cent.
When things get really ugly, that will be the time to buy stocks at bargain prices.
But we're not there yet. Not by a long shot, he says.
© The Globe and Mail
