This forecast, that Wall Street credit-crunch-related losses could eventually total $460 billion, is mind-numbing. Consider that less than two weeks ago, the markets staged a rally on the comparatively cheery S&P forecast that a subprime bottom was in sight, that the total damage would be a mere $285 billion, and most of the rest of the hits (writedowns at major firms so far have been $150 billion) would be at smaller banks (implication: no one cares all that much if they die).
By contrast, equities appear to have shrugged off the Goldman piece. That to me says we have not reached a bottom in stock prices. One of the features of a bottom is that pretty much all bad news is taken seriously, and good news is ignored. The market is not only perking up on good news, it is often selectively reading news reports and focusing on good bits.
Back to the Goldman piece. One of the reasons the total is so high is that Goldman included Fannie and Freddie in the $460 billion damage (anyone who has access to the report is encouraged to comment if they estimated their losses separately. But even if you are generous and attribute 1/3 of the $460 billion to the GSEs, that still leaves over $300 billion to come out of the securities industry’s hide in total.
Note also that the Goldman team, unlike other sources, counts the Wall Street losses so far at $120 billion (my recollection is that earlier lists indeed defined the securities industry overly broadly and included losses at Countrywide, Wamu, et al. in the total) and compute that only $100 billion has been replaced. So the securities industry may only be 1/3 of the way, or even less, through the crisis. This is consistent with past real estate recessions in the US and abroad taking a long way to work through the system, and the profile of subprime, Alt-A, and option ARM resets, which continue in significant numbers through 2011.
There are some inconsistencies in the reporting on this research note between Bloomberg and Reuters,; those may reflect nomenclature issues in the report. Both make it sound as if the $460 billion refers to Wall Street, meaning the securities industry rather narrowly defined, which is consistent with their claim that only $120 billion, rather than the more widely reported $150 billion of losses to date. Yet the Reuters report says these are the losses expected at “leveraged institutions” and included banks and hedge funds on the list. But it isn’t clear that the $120 billion includes hedge funds losses and failures to date (ie, the use of the smaller $120 billion figure implies a narrower definition of the industry, yet the notion of “levered institutions” is very broad).
For those who think hedge funds don’t count, remember, the geared ones had to borrow from a prime broker, meaning the Street, and their funds under management come increasingly from institutional investors, such as pension funds, insurers, and endowments. We are all exposed to hedge funds, like it or not.
No matter how you carve up the baby, the recapitlaizatoin needs to come from somewhere, and sovereign wealth funds are unlikely to contribute much until they believe a bottom has been reached, which will be after the vast majority of the losses have been disclosed. Similarly, to raise that much from the equity markets would be massively dilutive, Most managements will wait too long, not looking for sufficient funding until conditions become acute. This is a massive bill-in-the-offing for the US taxpayer in one form or another.
As we said before, this degree of carnage has the potential to create a deflationary crisis. There have been comments on the blog and e-mails from readers indicating that they are sufficiently worried about bank failure that they are considering pulling their cash out of their current bank (ie, they don’t trust that the FDIC will reimburse them quickly) or outright hoarding cash. I had rejected earlier reader suggestions, post Northern Rock, that we could see bank runs, but that psychology is starting to take hold, I may be proven wrong on that one, which would be a very bad development. And merely widespread putting money in mattresses, without any runs, would still have deflationary effects.
Goldman Sachs forecasts global credit losses stemming from the current market turmoil will reach $1.2 trillion, with Wall Street accounting for nearly 40 percent of the losses.
U.S. leveraged institutions, which include banks, brokers-dealers, hedge funds and government-sponsored enterprises, will suffer roughly $460 billion in credit losses after loan loss provisions, Goldman Sachs economists wrote in a research note released late on Monday.
Losses from this group of players are crucial because they have led to a dramatic pullback in credit availability as they have pared lending to shore up their capital and preserve their capital requirements, they said.
Goldman estimated $120 billion in write-offs have been reported by these leveraged institutions since the credit crunch began last summer.
“U.S. leveraged institutions have written off less than half of the losses associated with the bursting of the credit bubble,” they said. “There is light at the end of the tunnel, but it is still rather dim.”
Of the cumulative losses expected by these leveraged players, bad residential home loans will represent about half, while poor-performing commercial mortgages will represent 15 percent to 20 percent.
The rest of the losses will come from credit card loans, car loans, commercial and industrial lending and non-financial corporate bonds, Goldman economists said.
Facing more credit losses, leveraged institutions have raised about $100 billion in new capital from domestic and foreign investors and reduced dividend payouts. This amount is more than three-quarters of the write-offs to date, the report said.
Further detail from Bloomberg:
“There is light at the end of the tunnel, but it is still rather dim,” Goldman analysts including New York-based Andrew Tilton said in a note to investors today. They estimated that residential mortgage losses will account for half the total, and commercial mortgages as much as 20 percent……
Goldman said the $460 billion in credit losses it foresees may “result in a substantial tightening in credit conditions as these institutions pull back on lending to preserve their reduced capital and to maintain statutory capital adequacy ratios.”