If you are like most investors you are probably beginning to wonder just how bad will the mortgage and financial crisis get?

I’ve been saying for some time that the developing financial crisis that started in the mortgage market has been underestimated by many people, including most certainly those who are supposed to have some good ideas about such matters — the economists.

The problem with many economists these days is that they are working for people who order forecasts that must in some way fit in with their hopes and expectations. For example, an economist who is working for say the NAHB, National Association of Home Builders, doesn’t want to lose his job or contract over some dang economic forecast that is a bit too pessimistic. The poor fellow must try to balance out what his own research shows against what his bosses wants to hear.

One economist who has to be given high marks for making independent assessments is Paul Krugman. Here is his latest take on the mortgage crisis.

“What started in subprime is likely to continue cascading into the markets and keep the economy down until 2010, economist Princeton Paul Krugman forecasts. Bottom line for homeowners: An average drop of 25%.

We’re probably heading for $6 trillion or $7 trillion in capital losses in housing. Some fraction of that will fall on owners of mortgages. I still think the estimates people are putting out there - $400 billion or $500 billion in losses - are too low. I think there’ll be $1 trillion of losses on mortgage-backed securities showing up somewhere.”

Should Paul Krugman be proved correct, and I think that he will be, the carnage among financial stocks is probably less than halfway done. At some point there will likely be a full court press panic as a major institution or two goes under. Something like Bear Stearns but even worse.

So far financial institutions around the world have written off about 208 billion in losses. If Krugman’s prediction of one trillion in losses in mortgage backed securities is correct we haven’t seen anything yet. This bear market, lead by the financial sector, is just getting started.

 It will probably only end after financial stocks are so cheap that most investors get ill at the very mention of them. 

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