Saturday, November 17, 2007

Living On The Edge

Leveraged to the hilt and loving it. Bloomberg (11.16.07):
"The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a 'substantial recession' in the U.S., according to Goldman Sachs Group Inc.

Losses related to record home foreclosures using a 'back- of-the-envelope' calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday.

Goldman Sees Subprime Cutting $2 Trillion in Lending

Not that big a deal, you say? Barron's (11.19.07), via The Big Picture:
"[$400 billion is] equal to about 2.5% of the capitalization of the U.S. stock market, 'equivalent, in other words, to one bad day in the market,' Hatzius writes.

What's different about mortgages is, in a word, leverage, he continues."

The Goldy Standard

"Most stocks are owned by traditional investors, such as individuals, mutual funds, pension funds and insurance companies, who don't use margin and don't short. In contrast, most owners of mortgages are highly leveraged, including banks, savings and loans, broker-dealers and government-sponsored enterprises such as Fannie Mae and Freddie Mac, according to Fed data, which don't count hedge funds."

"This distinction makes a huge difference. If, say, these leveraged players account for $200 billion of mortgage-related credit losses, and they lever up 10 times, that hit results in a $2 trillion reduction in credit, Hatzius theorizes."

"This would be a shock equal to 7% of total debt. Such a credit contraction could produce a large recession, if it happened in a short period such as a year, or a long period of sluggish growth -- say, over two to four years, he adds."

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