Goldman: Wall Street Faces $460 Billion in Debt Writedowns

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.

From Reuters:

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.”

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  1. Mikkel

    Yves, I’ve taken out a few months of expenses into cash and recommended to family and friends they do the same.

    My primary reason was when I read this post:

    and the companion post that shows the FDIC only has $51.8 billion dollars in reserve, or less than 1.5% of the insured deposits (not even including the FHLB and other first in line people).

    Do you see anything wrong with those posts? The key point is that the entire FDIC system seems to be built on the premise that it won’t actually have to pay out because the failed bank will have enough collateral to sell off to other banks. With the massive concentrations in CDOs, et. al as well as excessive CRE loans in regional banks, I think this premise is false.

  2. Anonymous

    It would have been nice if Goldman tallied up the entire existing capital base for this set of institutions that they forecast those losses for.

    That way we would have an idea as to how much capital surplus (or deficit) would be left after taking all those losses.

    Any remaining capital deficit would have to be ponied up by the US government. This would provide a better idea as to how much of our entire financial system may have to be nationalized at the end of all this.

  3. S

    Check out dizzard piecxe in ft he is essentially saying the same thing in the form of a massive equity raise for banks.

  4. TallIndian

    Sorry to be OT (and I do have too much time on my hands), but I took a look at the Fed Res Act. Section 13(13) of that act is very clear in that an loan to private corp cannot exceed 90 days and must be backed by Tsy or Agy collateral.

    I don’t know who they can get away with this obvious violation.

    Subject to such limitations, restrictions and regulations as the Board of Governors of the Federal Reserve System may prescribe, any Federal reserve bank may make advances to any individual, partnership or corporation on the promissory notes of such individual, partnership or corporation secured by direct obligations of the United States or by any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States. Such advances shall be made for periods not exceeding 90 days and shall bear interest at rates fixed from time to time by the Federal reserve bank, subject to the review and determination of the Board of Governors of the Federal Reserve System.

  5. Anonymous

    I keep a small stash of “emergency” cash in the house, and I’ve talked with the wife about keeping more on hand, as the poster above suggests, enough for a few months’ expenses, in the event of major disruption in the banking system. She doesn’t want to do it, but the idea is definitely out there. And what, exactly would be wrong with a little deflationary pressure? The banks obviously can’t be trusted with our money, and they’re giving crap for interest rates anyway.

    (I also have a sack of old silver coins on hand!)

  6. Anonymous

    Maybe there’s a simple explanation for how the market is reacting to good news and bad news lately.

    Short-term treasury yields are at a 50-year low; the commodity bubble is apparently popping; overseas markets in 2008 have been tumbling comparatively far more than the US stock market; investment-grade corporate bonds have fallen and might fall further due to credit-crunch victims selling… so where else are people going to put their money? If they’ve run out of alternatives and they’ve got “bad news fatigue”, maybe they just sigh and put their money in good old US equities.

    And certainly the seemingly successful resolution of the Bear debacle (and the miraculous recovery to $10) seems almost scripted to make people believe the worst is over…

  7. S


    Interesting to note that the banks are taking in record deposits despite it all. People have nowhere to go for yield – and the risk seeking behavior the Fed and CNBC want to desperately to ignite remians soaking wet. [As an aside I almost choked this mornign when I saw that moron from Cumberland advisors – a CNBC shill – quoted in the FT calling yet another bottom.] I wonder if people would be so willing to hand their money over to the bank if they knew it was the funding mechanism for recap.

    Doesnt the Fed have an extraordinary clause whereby it can take any assets in extenuating circumstances circa depression?

  8. Anonymous

    Attributing 1/3 of the $460 billion loss estimate to the GSE’s seems far off the mark. The serious delinquency rate was recently reported at 1.06 % by Fannie. If the horror tops out at, say, 2% of the entire $2 trillion book, and the GSE weather a 50% loss on those forclosures, that amounts to $20 billion of losses (this I suggest is a quite conservative number given the private mortgage insurance and other credit enhancement standing in front of agency MBS and an assumed doubling from here of serious foreclosures).

  9. Anonymous

    Is there any reason the fed and helicopter ben would be unable to create hyperinflation, if the scenario you talk about was about to unfold? I’m not sure how much a hyperinflationary scenario is better than a massive run on banks, but it does feel like the quick rise of prices are more easily adapted to, than would be instant mayhem of bank runs.

  10. Yves Smith

    Anon of 10:25 PM,

    Thanks for the help. I was just making a guesstimate that was higher than what the GSEs could account for. Sounds like I overshot considerably. But that means the losses to the securities industry will be even greater.

  11. Yves Smith


    Thanks for the reminder re the implod-o-meter, forgot to look them up. But I do wish per Anon of 8:24 that I had or could easily locate a total for the equity capital of the securities industry and banking industry.

    Mikkel and Anon of 9:57 PM,

    This is one of those problems where behavior that looks rational on an individual basis can produce very bad results in the aggregate.

    If everyone started holding several months of cash, that could lead to deflation. Do you want to be part of the behavior that leads to a deflationary crisis and, say, a fall of GDP of 10% in one year? Those are the sort of outcomes that banks runs and deflation produce. That’s why the Fed feels justified in doing the sort of things that this blogger and many readers take issue with.

    I have not done the research myself, but there have to be local/regional banks that are not too exposed to the credit mess. I might use their price performance over the last year as a first screen and dig a bit re the composition of their assets and their loss reserves versus chargeoffs. It may seem impossible to believe, but not all banks are risky or badly run.

    Moreover, a straight payout from the FDIC is not the only route for getting benefit of its involvement. The FDIC also uses the purchase and assumption method, whereby a sound bank takes over some or all of the assets and liabilities of a failed or illiquid bank. It doesn’t use its assets in those brokered marriages.

  12. Olesh

    A couple of things, if you look at the ABX subprime index by vintage you can come up with an estimate north of $500 Billion in write downs just based on the pricing of those securities and the total amount of those loans written since ’05. Assuming half of this is at the levered institutions at 10x leverage that is a $2.5 trillion contraction.

    This does not count all of the other loans that may be in doubt.

    If the GSE’s are looking at 1.5% loss, I would worry about capital adequacy. At 40x leverage (we can debate about the NOL) Fannie and Freddie would look quite precarious.

    Are we in the eye of the 1000 year storm or are we just feeling the outer bands?

  13. Mikkel

    Yes Yves, that’s why I keep more in than I’d ideally like to, and have found a regional bank that I hope is OK.

    But the amount of deposits is pittance compared to the scope of the problem. Looking at the logical progression, I am primarily concerned that all the junk will get marked to market at once and there will be chaos. (Or the counterparties fail which is basically the same thing.)

    If someone could convince me that the long term structural problems aren’t that bad and can be resolved, then I would hesitate to take money out, but I don’t think this is like the classic bank runs that were set off on mere rumors. The big boys are definitely not sitting still (I think Krugman’s note about how the mass flight to treasuries might take away all control from the Fed is fascinating) and the government is not prepared to accommodate us if something does happen.

    In general, I think the problem isn’t human nature, but that our system isn’t built in a way that accounts for feedback loops that are entirely rational. I do hope that something fundamental changes, and soon.

    I also would question that moving the money to a bank that is being reasonable would really help the situation all that much because they aren’t going to start suddenly taking risks in order to try and stave off deflation.

  14. Yves Smith

    Agreed if we get serious deflation, a lot of players will pull their horns in even further. But the hope is that we won’t have that. But I also agree, and have been saying, that the financial system looks pretty precarious, and wasting firepower to shore up markets too big and (eventually) too underwater to save is a terribly inefficient, indeed, counterproductive way to go about this.

    I would try to be careful in how you instruct financially not so literate friends and colleagues to arrange their affairs, Too many people saying that banks are in trouble (to the point that there are worries about large scale failures) can be self-fulfilling. I would low key it but deliver the same substance, and stress that some banks are more prudently managed than others.

    It doesn’t help that, thanks to the formal end of Glass Steagal (it was dead long before it was officially buried) the media uses the term “bank” to refer to traditional banks and what the Bank of England called “large complex financial institutions” some of which are pure broker dealers (Goldman, Lehman, Merrill), others are what the Europeans called universal banks (Citi, UBS, Barclays) with securities operations plus commercial and retail banking.

    The risk and consequences of failure are a much greater in the LCFI and their slightly smaller kin (Bear) than in traditional banks, ex the ones that jumped in with both feet on the subprime bandwagon. Banks are kept on a much shorter leash.

    The big broker dealers are far more important to credit intermedation than banks are. Failures there will put lending in a deep freeze (most banks on-sell a big chunk of the loans they originate). If the securitization process continues to be impaired, traditional banks have no where to go and will run into balance sheet constraints pretty quickly. So we can get a big time lending contraction without bank failure or even serious impairment of traditional banks.

  15. Anonymous

    The regional banks are heavily exposed to construction loans. They are not necessarily a safe haven.

    The problem with this system is that all the banks are interlinked through derivatives. At the same time, there is little transparency.

    The derivatives combined with the lack of transparency means that if any single reasonably-sized financial institution fails, then everyone will make a run on all of the other banks because of fear of the unknown (which counter-parties the failed institution would bring down because of derivatives default). So the collapse of any single component in the system causes the collapse of the entire system (and a Great Depression).

    As a result, nothing in the entire system can be allowed to fail—nothing.

    That is the harsh lesson we are learning about derivatives and transparency. Pandora’s Box has been opened. It is derivatives that have set the stage for potential systemic collapse.

  16. Anonymous

    Wait!! I thought Goldman was short the CDO market–now their “analysis” shows $460 billion in total eventual losses–how convenient, and suspect. I wouldn’t believe anything Goldman says–esp. since they were selling CDO’s on the one hand, and simultaneously shorting them on the other–oh excuse me, that is a form of “arbitrage”?

  17. eh

    Agreed if we get serious deflation, a lot of players will pull their horns in even further. But the hope is that we won’t have that.

    I guess. But what is this hope based on? Isn’t it so that in the last few years aggregate debt, especially household debt, has risen dramatically compared to incomes, i.e. the ability to service that debt? Are there any signs, in this age of outsourcing and ‘labor arbitrage’, that incomes are going to catch up in any kind of reasonable time frame? I just don’t see it. So how can we possibly avoid asset deflation, e.g. home prices, where in some areas affordability, as measured by historic norms, is totally out of whack?

    Looking at this graph, I’d guess prices have fallen somewhat less than half way (in real terms) to the eventual bottom.

    I think we all know, anecdotally, that things have gotten far out of balance. And just as crazy as all that was, the Fed is behaving just as crazily trying to stop the inevitable correction.

    Like I said before: IMO such a correction is needed to show Americans the wrongheadedness of a FIRE dominated economy.

  18. Yves Smith

    Goldman was short subprime last year. Dunno if they are now, particularly since Blankfein declared the housing crisis to be more than halfway over.

    Goldman also bought Litton Loan Sevicing, a subprime servicer of a very nasty sort, last year (won the bidding in October, deal was supposed to close before year end). That looks like a bet the bottom was nigh. Servicers are hemorrhaging cash right now, so this probably is not the best deal Goldman ever did.

    Long way of saying it isn’t clear they are talking their book. .

  19. a

    I’d recommend to everyone to keep a month’s worth of cash, in case of a bank holiday. I guess in a bank holiday that credit card use would be restricted or disallowed, but not too sure about that one. I’ve made this suggestion to people outside the U.S. as well. It seems pretty much common sense at this point.

    We survived the Great Depression. Most people kept their jobs and most banks didn’t go under. There was great suffering, obviously, but as long as there are no Hitlers or Musolinis in the wing today, we should get through this mess.

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