It was such a small news item in the paper I almost missed it. A hometown bank was being acquired by a rival. For a fraction of its estimated value. The reason: large real estate losses.

As I travel around the country, I come across other stories of the mortgage crisis, sometimes in unexpected ways. In southern Florida, a development looks tidy and prosperous during the day. At night, you drive through the neighborhood and see lights in every third or fourth house. The others homes are empty—not just foreclosures, but also properties abandoned by the developer or investors.

Another data point: Near Vanguard headquarters a new multi-use development began to take shape several years ago. It was an exemplar of the “new downtown” philosophy of suburban development. I remember distinctly when it was profiled on a national radio news program as a model for the nation.

Today, most of the land, partially developed, is surrounded by a neat white fence—a victim of the downturn. Our local area had largely escaped the larger housing bubble. So the project was probably a victim of the economic downturn, not mortgage speculation.

All around the nation, we see evidence of what has been referred to as a “balance sheet” recession, an economic downturn arising in the financial system. Trillions of dollars of real estate wealth, backed by trillions of mortgage dollars, have evaporated, leaving holes in the balance sheets of households and financial institutions. There has been a massive destruction in the value of housing-related capital.

As mentioned in a previous post, households are saving ferociously (at least when compared with five years ago) to fill in the financial hole. Financial institutions are doing the same, using profits to build out their capital base (and meet higher requirements from international regulators).

The one private entity seemingly immune from these problems is the nonfinancial sector. Nonfinancial companies repaired balance sheets over the past decade, unaffected by speculation in the mortgage system. Today they are sitting on loads of cash—many waiting for a more vigorous recovery before they invest.

Most of our experience understanding the economy comes from the traditional boom-bust of the business cycle. Companies overproduce, high consumer demand drives up inflation—and economic policymakers have to intervene to cool off the economy. Balance sheet recessions, where a financial crisis engenders a downturn, are few and far between, making it difficult for federal policymakers to predict what will work, and how long a full recovery will take. The current recession is exacerbated by the magnitude of the dollars involved.

The good news is that the economy will recover—not just to higher rates of growth, but also to higher rates of employment. With balance sheet repair still under way, however, the path to a full recovery is harder.