$1.6 Trillion in Losses and Counting
The crisis in the international banking system.
Last quarter, we saw estimates approaching $1 trillion. By last week, the number had jumped to $1.6 trillion, according to Bridgewater Associates, one of the top analytical firms in the world.
In this week's letter, I want to look at that projection and its implications, analyze recent lending patterns by banks, examine the latest unemployment numbers and end with a few comments on the bear market. It should make for an interesting letter.
Warning: Before reading, make sure you don't have any sharp objects close to hand.
But first: I need your help. In return, I'd like to give you a link to a recent speech I gave on the development of an important new asset class brought about by precisely those problems I am writing about today. The speech has been well-received, and I think you'll like it. Now, as to how you can help me:
I get to travel a lot with my daughter and business partner Tiffani (who actually runs the business). We meet many new people, all of whom have a story to tell or a lesson to teach. Over the years, she's become as fascinated by their individual stories as I am. We've decided to write a book containing those stories, looking at the differences in perspective between old and young, retired and working, those who are wealthy and those who aspire to wealth. What are the differences in attitudes, in work habits, in how you manage money, in how you look at the future?
We've created a totally anonymous online survey seeking answers to these and other questions. We hope to get at least 10,000 people to fill it out; we're eager to engage in a lot of in-depth analysis of the resulting data. Are the rich really different? Are people from Europe, Asia, Latin America, Africa and the U.S. different from each other? Please note: This survey isn't only for millionaires. We want everyone, of all income levels and ages, to take it, so we can get a truly representative sample.
You can get to the survey page by clicking here. It'll take about ten minutes to complete, and I think that going through the questions will make you think about your own situation. Some have told us the survey is quite thought-provoking. If you have attempted to take the survey and had problems, we think we have worked out the bugs.
At the end of the survey, you'll be given a link to my speech. If you can't listen to it immediately, then simply save the page or the address. And you can of course take the survey just to help us out.
Tiffani and I also want to do live (mostly by phone) interviews with 200 millionaires, of all shapes and sizes and locales. We will interview you for about 30 minutes, and then you can have equal time asking me anything you want. Since I will have learned a lot about you, those questions can be as detailed or as general as you like. We want at least 20% of the interviews to come from outside the US. We will use those interviews in the book, but will attach no identifying items or real names. If we use something from your interview in the book, we will let you see it first. If you are interested in being one of the interviewees, just drop Tiffani a note at firstname.lastname@example.org and she will get back to you and work out the details.
I'm really excited about this project and even more so about working with Tiffani. We will report back to you on what we find. Thanks for your help. And if you have any questions, please feel free to reply to this email.
$1.6 Trillion in Losses and Counting
I have the great privilege of reading a wide variety of economic research. While I get a lot of material direct from the source, I also have a wide network of people who read other sources and send me what they think is important. When Ambrose Evans-Pritchard wrote this week about a report done by Bridgewater Associates, it got my attention, and fortunately this report was sent to me by a few friends. In my book, Bridgewater is one of the top analytical groups in the world. I pay attention and give strong credence to what they write. And this report is quite sobering.
First, let's look at what Evans-Pritchard wrote in the London Telegraph:
"Bridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn [$1.6 trillion], four times official estimates and enough to pose a grave risk to the financial system.
"The giant US hedge fund said that it doubted whether lenders would be able to shoulder the full losses, disguised until now by 'mark-to-model' methods of valuing structured credit.
" 'We are facing an avalanche of bad assets. We have big doubts as to whether financial institutions will be able to obtain enough new capital to cover their losses. The credit crisis is going to get worse,' said the group in a confidential report, leaked to the Swiss newspaper Sonntags Zeitung.
"Bank losses on this scale would have far-reaching effects. Lenders would have to curtail loans by roughly 10-to-one to preserve their capital ratios. This would imply a further contraction of credit by up to $12,000 billion [$12 trillion] worldwide unless banks could raise fresh capital."
Let's look at some of the details in the report. First, these losses are not all subprime. In fact, more than half of it is from corporate liabilities, around $800 billion. About $550 billion of the corporate losses have yet to be written off. As an example, Bridgewater estimates losses on commercial loans to be as much as $149 billion, none of which has been written off.
Better than 90% of the losses from subprime assets that are on the books have already been written off. That is good. But Bridgewater estimates that there are losses lurking in the prime and Alt-A loan portfolios that could be much bigger than the subprime problems, as those loan books are more than six times the size of the subprime:
"The US commercial banks are in a position to suffer the greatest losses, because the core of their portfolio is risky US debt assets. In order to get a sense of their expected losses we examine both their loan book and their securities portfolio and price each type of asset out based upon a reference market. If we use this current market pricing as a guide, there is a long way to go, as these institutions have only acknowledged about 1/6 of the expected losses that they will incur as a result of the credit crisis."
I could go on, but the details are not important. The bottom line is that they estimate there is at least another $1.1 trillion of losses that will have to be written off by institutions all over the developed world, including very large potential write-offs from insurance companies.
Banks and investment institutions worldwide may need another $400 billion in capital infusions. But where they are going to get it is the problem. They have burned through the usual suspects, and burned is the correct word. Any sovereign wealth fund or large investor who has put money into an investment or commercial bank has watched their investment take large losses in a very short time. How likely are they to be willing to belly back up to the bar with more money, on anything except very dilutive terms to current shareholders? The answer is obvious.
And let me be clear. There are some very large commercial and investment banks which are simply going to be absorbed, as regulators move to keep the entire system working. Bear Stearns is not a one-off deal. I think it is likely we will see at least one European bank nationalized. Losses the size that Bridgewater describes are beyond ugly. They are life-threatening for more than one major institution. More on this later.
Banks Start to Reduce Their Lending
Further, let's revisit a theme I have written about on several occasions over the past year. As banks incur losses, they either have to find new capital or reduce their lending in order to maintain their capital ratios, or some combination of both. And what we are seeing is that lending is starting to actually decrease.
Earlier this year lending rose as normal, even though anecdotal reports told of tightening lending standards and reduced loan lines. The tightening of standards did not seem to be affecting actual loans being made, which was odd. But this was partly illusion, as banks were taking back loans they had spun off in SIVs, taking capital away from their traditional loan business. This gave the appearance of expanding loan capacity. Evidently, this bringing back of off-book loans is now being worked through, as evidenced by this analysis by good friend and analyst par excellence Greg Weldon, who slices and dices the data to give us this view:
"For sure, the recent decline strongly suggests that the risk of a US recession has intensified considerably, as defined by what amounts to one of the largest nominal credit contractions in decades, at (-) $154.3 billion, and a clear-cut violation of the uptrend in place since at least 2001."
Greg goes on to suggest that bank credit could contract a further $6-700 billion over the next nine months, which is a contraction of about 8%. Healthy economies have a rising rate of bank credit, which is one source of expansion. When banks have to reduce their lending, it reduces the growth of the economy or can put it into outright recession.
And if the Bridgewater report is anything close to right, Greg is being an optimist, which is not his normal milieu. Now, do I think worldwide credit will shrink $12 trillion, as Evans-Pritchard suggests? (Note: That wasn't a suggestion or conclusion by Bridgewater.) Not in my worst nightmares. Capital will be raised, and the various central banks of the world will do what is necessary to give banks the time to work through their problems.
But in the meantime, the trend toward lower lending is likely to continue. And lower lending is going to be a huge headwind for an economy that is already struggling.
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