Credit Losses 'May Reach $400bn'

November 16 2007

Source: BBC News

Financial companies' losses due to the US sub-prime crisis could be as much as $400bn (190bn), US investment bank Goldman Sachs has said. The estimate by Goldman's chief economist Jan Hatzius is higher than that of the Federal Reserve but in line with some recent independent forecasts.

Mr Hatzius predicts leveraged investors may have to reduce their lending by $2 trillion as a result. "The macroeconomic consequences could be quite dramatic," Mr Hatzius said. He said the development could lead to a "substantial recession" if it happened over a year, or to a prolonged period of weak economic growth if it occurred over up to four years. The economist's calculations are based on the estimate of investors cutting lending by $10 for every $1 in losses and on the assumption the investors would see half of the potential losses of $400bn.

"The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognised," he said. "While the uncertainty is large, the associated downward pressure on lending raises the risk of significant weakness in economic activity."

Mr Hatzius said the analogy that a $400bn loss "is just an equivalent to one bad day in the stock market" is wrong as most equities are held by the type of investors who "do not adjust their portfolios in response to a capital loss".

Meanwhile, for the first time in several years the bond's yield - considered to be a measure of the company's default risk - for the largest financial institutions exceeded the yield of the average company's bond. Usually, the higher the risk, the higher the yield would be, as the bond's issuer has to offer investors a certain compensation for the risk. It means that now banks, insurance companies and brokerages must pay more for borrowings in the corporate bond market than the average company.