Prepare for a very nasty hangover

Pundits hope the worst may be over after the panic surrounding Bear Stearns’ near-collapse. But until the US housing market - the root cause of the credit crunch - bottoms out, jitters are likely to continue.

Hope springs eternal. Pundits have been saying that the worst may be over following the panic surrounding Bear Stearns' near-collapse. But there is little evidence of the sort of "washout level of gloom required to clear the air", as Ambrose Evans-Pritchard puts it in The Daily Telegraph.

Global earnings, for instance, are still expected to rise by 11% this year and US S&P 500 profits by 15%. It seems "people are so eager to make the transition from late-cycle to early-cycle growth they've leapfrogged over the recession in between", says Merrill Lynch's Peter Bernstein.

On the credit front there is scant sign of tension easing. Banks continue to hoard cash: interbank rates are at their highest levels this year. No wonder, then, that US mortgage rates remain "stubbornly high" despite the Fed's rate cuts, says Julie Creswell in the International Herald Tribune.

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In the housing market, the root cause of the credit crunch, price falls are accelerating and there is no sign of a bottom. Given how lending standards deteriorated in 2005-2007, an "enormous wave" of defaults and foreclosures is "just beginning" to break, says T2 Partners.

Until housing bottoms out which may require intervention by regulators and governments and banks can assess the scale of their losses, jitters are likely to continue. UBS this week warned of another $19bn of writedowns in the first quarter, having lost $18bn last year. And with securities related to car, credit card, student and leveraged loans set to slide as the economy worsens, there will be plenty more bad news dribbling out and eroding confidence over the next few months. Goldman Sachs is pencilling in global losses of $1.1trn.

Moreover, the sheer scale of the run-up in housing and debt over the past few years suggests that the unwinding process is far from over. "The imbalances are the kind that take years, not months, to correct," as Authers says. Financial services' share of the economy has doubled over the past 50 years. House prices across ten major cities more than doubled between 2000 and 2006 alone. Americans' personal saving rate, 12% in the early 1980s, dropped below zero in 2005.

Over the past 25 years household debt has doubled as a proportion of GDP; as a percentage of disposable income it has hit 130%, rocketing from below 100% in 2000. Between 2001 and 2007, debt by this measure jumped by more than in the previous 40 years combined, notes David Rosenberg of Merrill Lynch, who also points out that "it is a truly grim situation" when the consumer sector spends more servicing the $14trn of debt on its balance sheet than it does on food. Of disposable income, 13.2% goes on the latter; 14.3% on the former.

The turmoil in the markets ultimately reflects the fact that an economic bubble, "financed by ridiculously loose monetary policy", is now "unravelling", says Albert Edwards of Socit Gnrale. For amid all the fuss about reckless borrowing by consumers and careless lending by banks, it was ultimately the Fed under Alan Greenspan that created the conditions for the debt binge of the past few years with historically low interest rates.

Greenspan is the "leader of the miscreants", as Jeff Randall puts it in The Daily Telegraph. Having fomented a bubble in stocks, the Greenspan Fed then "chose to cut short the aftermath by creating a housing bubble", says Bill Fleckenstein on MSN Money, with all this easy money encouraging excessive risk-taking and ever more imaginative financial innovation. The party was prolonged with easy money so the ultimate hangover is set to be very nasty indeed. Greenspan has now said that the current US financial crisis is likely to be "the most wrenching" since World War II. Well, he should know.