(Agencies)
Updated: 2007-12-19 10:41

Washington -- Few people knew at the start of 2007 the meaning of "subprime" real estate loans or how they might affect the US and global economies.

Today, worries are growing that the crisis that began with mortgage failures and spread to banks and brokerages may push the US economy into a downturn and put the entire global economy at risk.

A real estate "For Sale" sign sits on a residential corner in Centreville, Virginia. Federal Reserve chairman Ben Bernanke said Tuesday that the central bank was proposing new rules to clean up mortgage lending which are also aimed at protecting home buyers from potential fraud. [Agencies]

Subprime loans flourished at the end of the US housing boom as lenders offered mortgages to people with shaky credit in an effort to cash in on surging prices.

These loans were packaged into securities that were sold to investors around the world, with little regard to what would happen when low "teaser" rates were reset to increase payments from homeowners.

When a wave of defaults began to hit, US and global banks began to see billions of dollars in losses on their balance sheets. The lenders had to tighten credit, crimping consumer and business spending and threatening the overall economy.

Goldman Sachs economist Jan Hatzius says his "back-of-the-envelope calculation" now suggests "losses of around 400 billion dollars" for global banks and investors.

Although this may not seem large in the overall economy, Hatzius says the effect is magnified because banks need to scale back their lending to keep capital ratios intact after accounting for the losses. As a result, he said lending could be cut by two trillion dollars.

"Even if this occurs gradually, and even if there are some offsets from reduced credit demand and increased lending by other sectors, the drag on economic activity could be substantial," said Hatzius in a note to clients.

Adding to the woes from housing are near-record energy prices and a weak dollar that could fuel inflation and hurt business confidence. Some say a recession is a possible scenario.

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