As things stand as of now, none of these conditions are satisfied.

The US economic slowdown is likely to be anything but mild, especially in the light of sub-prime crisis. With the pain of the sub-prime crisis seemingly only half way through (a write-off so far to the tune of about $500 billion as compared to an estimate of $1,000 billion), its spillover impact on the real economy seems to have just begun and is no where near to have been played out.

About 100 US banks might fold up

First, the likely impact of the sub-prime crisis. According to Institutional Risk Analytics, about 100 banks are likely to fail between now and July of 2009. Most of them will be small, but there will be a few large banks.

The total assets of those banks are estimated to be $850 billion. Those are the assets the FDIC (Federal Deposit Insurance Corporation) is going to have to cover when they take over the banks.

Take Washington Mutual as an example. Their debt now trades at 20 per cent, which is worse than junk. There is no way they could issue preferred stock to recapitalize their business. And they are going to need more capital, as they have write downs in their future due to the slowing of the economy.

Any common issue would have to seriously dilute existing shareholders almost to the point of nothing.

The FDIC has about $50 billion. These reserves have been built up over the years from deposit insurance paid by banks that are part of the programme. They are going to need an estimated $20 billion just to cover the failure of Indy Mac.

The FDIC will have to cover only a small percentage of the $850 billion, as some of those assets will surely be good. But if they have to cover 10 per cent, then the FDIC would need another $50 billion. Not a very encouraging scenario.

And then there’s Freddie Mac and Fannie May. Companies that were leveraged more than 60 times the owners fund and covered half of the $12-trillion mortgage market.

Their effective nationalization, while addressing the short-term concern (especially the likely catastrophic effect of these institutions going bust), however, will not be a solution to the basic problem and will also come at a great economic cost. Insurer American International Group too has received a $85-billion bailout from US Fed. The Fed will extend a 24-month bridge loan of $85 billion to the insurer, in return for an unprecedented acquisition of a 79.9 per cent stake in the firm by the central bank.

How many more write downs and credit losses are expected, both in the US and abroad?

The Federal Reserve Board published a paper recently with the title: Foreign Exposure to Asset-Backed Securities of U.S. Origin (by Beltran/Pounder/Thomas). According to Dr Nouriel Roubini, the Federal Reserve’s Flow of Funds data reveals that foreigners hold about 39 per cent of outstanding ABS (asset-backed securities) backed by US assets. Therefore, foreigners will bear 39 per cent of any mark-to-market markdowns associated with those securities.

US economy faltering

In this backdrop, how is the US economy going to fare?

The perennially consumption-driven US economy is facing a strong headwind of faltering demand and even more likely anemic demand going forward. The traditionally low-saving US consumers went on a consumption binge as positive wealth effect kicked-in following the abnormal rise in home prices. Click here for Part II.

• US sub prime crisis spooks global economy: Complete coverage