A complete sub-prime user's guide, 2007 edition

Anyone looking to reflect on the high points of the year in business and finance can pretty much do it in one, maybe two, words: subprime mess.

How the non-payment of mortgage interest by a homeowner in Ft Myers, Florida "" and others like him "" morphed into an international credit crisis, heaping such huge losses on Wall Street that its biggest banks had to look overseas for a capital infusion, is a story that will be told for years to come. Maybe Wall Street memories will be longer than the crisis this time around.

For those who may have missed the subprime press coverage or been too intimidated by the acronyms to dive in, herewith is a user's guide to the subprime year of 2007:

S is for the Subprime loans that were sold to Wall Street, Securitized and snapped up by Structured Investment Vehicles, which ran into trouble funding themselves. All of these "S'' characters, independently, may have been well-intentioned initiatives: to encourage homeownership, to transfer risk, to turn a profit. Together, they were a lethal cocktail.

When home prices stopped rising, then started falling, subprime borrowers couldn't refinance homes they couldn't afford to begin with. They defaulted on their loans.

In the end, the various intermediaries between borrower (homeowner) and lender (investor), not to mention their divergent interests, is proving to be a hurdle to a timely resolution of the problem.

U is for Unreported losses. Banks have been offering up mea culpas for their third- and fourth-quarter losses after a record first half. Commercial and investment banks worldwide have reported writedowns and losses of more than $80 billion so far. Fear of more to come has crimped interbank lending.

One view holds that banks are being aggressive now so they can start the new year with a clean slate and, in some cases, a new CEO. If that's the case, why do the announced losses continually outpace what was anticipated just a few weeks ago?

B is for Boohoo, Bonus foregone. Morgan Stanley Chief Executive John Mack said he would take a pass on the bonus pool this year following the investment bank's first-ever quarterly loss. Presumably Mack has a portion of his $42 million 2006 compensation tucked away somewhere, having invested it more wisely and safely than his firm, which wrote down $9.4 billion in mortgage securities in the fourth quarter.

Bear Stearns CEO Jimmy Cayne and senior executives won't reward their poor performance with a bonus either. The firm reported its first loss as a public company.

P is for Paulson. That's Hank Paulson, formerly of Goldman Sachs Group, now of the US Treasury. Paulson has hatched or encouraged one plan after the next to soften the fallout from the mortgage meltdown. (It may be the neighbor's foreclosed house, but it's your property that goes down in value.)

The impetus for a bank-backed "SuperSIV,'' which would buy high-quality assets from little SIVs and finance them with the banks' commercial paper, is waning as some financial institutions (Citigroup Inc, HSBC Holdings) assume the liabilities of their SIVs. Other banks have said no thanks.

Another plan proposes to freeze the teaser rates on certain subprime loans. Paulson isn't getting great reviews. He'll be long gone before the ultimate votes are in.

R is for Regulation, Recession. The same senators and representatives who prodded lenders to extend credit to low-income folks in the 1970s and 1980s to help them buy homes are now horrified that the objects of their beneficence got put into loans they couldn't afford.

Congress, which is always passing laws to prevent the last crisis, is considering a host of options from the benign (supporting more regulatory guidance) to the ridiculous (shifting the liability for predatory loans to investors). Heavy-handed measures may end up impeding the revival in residential real estate once inventories and prices come down.

The odds of a recession next year are rising, according to many economists. The Federal Reserve was slow to recognise the magnitude of the subprime problem, and quick to try different tactics, other than a reduction in its benchmark rate, once it did try to get credit flowing again. (If lowering the discount rate doesn't reduce the stigma of borrowing directly from the Fed, create an anonymous facility for banks to bid for funds.)

I is for Interest rates, which are apt to come down in the new year. Central banks have been busy acting as lenders of last resort. The European Central Bank loaned a record 348 billion euros ($500 billion) for 14 days, which had the effect of reducing interbank rates by 50 basis points.

Once the banking system's immediate cash needs are met, it will be back to the more mundane job of ministering to the economy.

In the US, with market rates still above the federal funds rate, the Fed will have to ease to return the yield curve to a positive slope.

M is for mortgage. See "S'' above.

E is for the economy, which will be the biggest loser from the housing bubble gone bust. Today's economy may be more resilient than in the past, but periods of excess credit creation tend to yield to periods of credit constraint.

From the Great Depression in the 1930s to the savings and loan crisis in the US in the early 1990s to Japan's lost decade of the 1990s, history suggests that when the banking system is impaired, the economy doesn't work.

The writer is a Bloomberg News columnist. The opinions expressed are her own