THE worst is still not over for the US financial services sector, as major banks, investment houses and mortgage lenders continue to report huge losses from exposures to the subprime mortgage market.
Goldman Sachs, in a recent research report, estimated industry-wide losses from declines in the market value of subprime mortgage-related collateralised debt obligation (CDO) to be almost US$150bil.
Write-offs in the third quarter of the year totalled US$18bil from financial firms globally while recent pre-announcements from some firms indicated US$22bil would be written off in the fourth quarter, suggesting US$108bil unaccounted for mark-to-market losses coming, it noted.
Paul Donovan
The Organisation for Economic Cooperation and Development has estimated that losses could even hit US$300bil. Earlier in the month, US banking titan Citigroup said it would have to write off up to US$11bil, far higher than anticipated. Other banks also warned of write downs, including Wachovia, Bank of America and JP Morgan Chase.
UBS Investment Bank believes the financial sector will generally continue to experience volatility, elevated credit spreads (including swap spreads) and less liquid conditions in the interbank market.
“We see these conditions persisting in some form or another for a further six to nine months,” deputy head of global economics Paul Donovan said.
Goldman Sachs noted that an inevitable implication of the current mortgage fallout was the need for certain companies to raise capital.
“We expect continued deterioration in the mortgage market to drive increasing rating agency pressures, ultimately forcing some companies to raise capital,” it said.
Others will have to preserve capital and managements will need to repair some seriously damaged balance sheets.
An increasing number of Wall Street analysts and US economic commentators have turned bearish and warned of an impending financial system meltdown and a “hard landing” for the economy.
The meltdown is now spreading to other residential sectors, commercial real estate and related securitised products. Credit cards, auto loans and other consumer credit are also at risk.
Goldman Sachs noted that falling home prices had put a third of the US, by gross domestic product (GDP), in or near recession.
“Card and auto losses will rise. If the economy is worse than expected, earnings revisions will be negative,” it said.
The downturn in housing is resulting in unemployment in some states and higher consumer losses.
Specifically, despite a still relatively low unemployment rate nationally, about one-third of the country appears to be in a recession, based on state-level employment deterioration and falling home prices as the yardsticks, Goldman Sachs said.
RAM Holdings Bhd group chief economist Dr Yeah Kim Leng said that with over 70% of the US economy being driven by consumer spending, the chance of a recession – two consecutive quarters of negative growth – in 2008 was probable.
“The US GDP growth in the fourth quarter is now projected at 1% or less as consumers are confronted with slower job growth, surging energy and food prices, resetting of adjustable mortgages, tightening credit standards and housing wealth decline.
“Although the falling dollar may help boost exports and lift corporate earnings, imported inflation will further reduce consumers’ purchasing power, thereby increasing the likelihood of a consumer recession,” he said.
UBS' Donovan said rising unemployment, low or falling real disposable income growth, job insecurity and other factors suggested negative sentiment.
“I expect this to be maintained for most of 2008. In my view, for most Americans this probably already feels like a recession,” he added.
Prudential Asset Management Singapore's investment marketing division sees the US economy as in transition, not recession.
It said economic “rotation” was cutting in – corporate investment was rising as household spending came under pressure.
“First, the backlog of corporate orders is at record highs and growing as the US dollar falls.
“Second, rising non-residential construction is now counterbalancing the fall-off in housing. These are powerful drivers that will take a lot to stop,” it added.
Furthermore, the company noted that the US economy was still growing.
Third quarter growth came in at 3.9%, stronger than the second quarter’s 3.8%. Also, a sharp improvement in both trade and budget deficits (as a percentage of GDP) has occurred; the trade deficit fell to its lowest level in 28 months spurred by a falling dollar.
“And more importantly, outside the financial sector, the declared profits remain indifferent to subprime noise,” Prudential said.
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