April 08, 2008
Distressing Table of the Day
Here's the basis for the $945 billion estimate of losses to the financial sector. From the IMF's Global Financial Stability Report:
Table 1.1 from IMF's Global Financial Stability Report.
Here's the text:
Broader credit deterioration, a weakening economy, and falling credit prices combine into a substantial hit to the capital of systemically important financial institutions.
We estimate aggregate potential writedowns and losses to be approximately $945 billion as of March 2008 (see Table 1.1 and Annex 1.2 for details on the methodology).23,24 Aggregate losses are on the order of $565 billion for U.S. residential loans (nonprime and prime) and securities and $240 billion on commercial real estate securities. Corporate loans (including leveraged loans and CLOs) are expected to account for $120 billion of losses, while consumer loan losses are likely to add an additional $20 billion. Most of the nonprime losses are in securities rather than unsecuritized loans. At present, pricing of mortgage-related derivative indices suggests higher losses than do calculations based on projected cash fl ows for the underlying loans.25 Since the October 2007 GFSR, ABS prices have declined between 20 and 40 percent across tranches rated AAA to BBB–, and as much as 50 percent on ABS collateralized debt obligations (ABS CDOs) across all ratings categories, refl ecting market expectations of future deterioration and illiquidity of the underlying securities. (See Boxes 2.2 to 2.4 in Chapter 2 for more details on the fragility of structured product ratings and their valuations.) Market prices continue to adjust on an almost daily basis, pressuring markto- market losses higher.
Potential credit losses would lower aggregate capital adequacy ratios at U.S. banks by about 250 basis points, and at European banks by about 150 basis points. Although aggregate ratios remain above regulatory norms, a bottomup analysis of losses indicates that some banks and regions will suffer disproportionately. Put in historical perspective, this crisis is of similar dollar magnitude to the Japanese banking crisis of the 1990s (Figure 1.12).
Uncertainty over the size and spread of losses further elevates systemic risks, even as markets price in losses for banks and insurance companies.
Global banks are likely to shoulder roughly half of aggregate potential losses, totaling from $440 billion to $510 billion, with insurance companies, pension funds, money market funds, hedge funds, and other institutional investors accounting for the balance.27 Banks generally hold the most senior tranches of these products, but even these are now likely to incur substantial losses (see Boxes 2.3 and 2.4 in Chapter 2). European banks hold sizable amounts of complex structured products such as MBS and CDOs and have been exposed to losses related to structured investment vehicles (SIVs) (Figure 1.13).
Posted by Menzie Chinn at April 8, 2008 08:52 AMdigg this | reddit
Listed below are links to weblogs that reference Distressing Table of the Day:
» IMF Global Financial Stability Report from PrefBlog
The IMF has announced: The widening and deepening fallout from the U.S. subprime mortgage crisis could have profound financial system and macroeconomic implications, according to the IMF’s latest Global Financial Stability Report (GFSR). At prese... [Read More]
Tracked on April 8, 2008 10:51 AM
So they're saying it won't come out of my index bond fund?
Posted by: odograph at April 8, 2008 10:21 AM
$945b = 2% of world GDP. Not the end of the world.
The dot-com bust was about $2 Trillion in losses, which was 5% of World GDP at the time.
That the US stock market is still not tumbling to lower levels is what makes me optimistic that most of the negative effect is already priced in.
Posted by: GK at April 8, 2008 10:45 AM
loss projections resulting from OTC derivatives have been on the rise ever since the 'credit crises'(i hate this term) was brought into the limelight. Despite the broader equity markets ability to 'hold up' i don't think the loss in equity index values (real or nominal) are over.
Posted by: Scott at April 8, 2008 12:26 PM
"$945b = 2% of world GDP. Not the end of the world.
The dot-com bust was about $2 Trillion in losses, which was 5% of World GDP at the time."
Well that $2 trillion will be wiped out by a 10% decline in house values alone. 20% isn't impossible at all, which would make it $4 trillion. Add to that the losses from loans and possible stock market declines.
What comes to market sentiment - the stock market will maintain it's optimism all the way down to the bottom. In bear markets it looks like the bottom is found many, many times. Is this now second, or third? In long bear markets the real bottom arrives years later when nobody is calling it anymore. Of course it's possible the market has discounted everything by now..
Posted by: Mr. Bail Out at April 8, 2008 01:48 PM
You're comparing apples to oranges. Two trillion USD that you're quoting is a decline in the value of U.S. equities. The table above is an estimate of Financial sector losses. The two are only related in that they are quoted in dollar amounts.
PS: If you're taking your queues from the stock market noise, I have some snake oil to sell to you. Markets don't have to crash in a single day to go down 30 percent. By all means, dump your money into equities if you think the continuing saga of bad news is "priced in" at an 11 percent decline from the all time high.
Posted by: matt at April 8, 2008 03:13 PM
"By all means, dump your money into equities if you think the continuing saga of bad news is 'priced in' at an 11 percent decline from the all time high."
Convincingly, and very amusingly, said. I'm still lol.
Posted by: don at April 8, 2008 08:32 PM
Just yesterday I read an estimate that Global Income is running around $50 Trillion dollars..
So are we saying that this mess is just a week's worth of Income?
Fine... lets take the week off an on to other things..
Posted by: phyron at April 9, 2008 05:30 AM
First, let me observe that financial sector losses are gains by net debtors. That is these are losses on inside, not outside, assets. So the impact is not comparable to the loss of value of equity, where the market is valuing physical capital less due to a reduction in projected earnings.
So why are financial sector losses important? The key reason is that these are losses in the "leveraged sector"; these losses will decapitalize the financial sector, forcing deleveraging, i.e., reduction in lending. See this post.
Posted by: Menzie Chinn at April 9, 2008 06:24 AM
This is a great site which I've been following for awhile.
I took a quick read at the IMF report to try to understand the methodology behind the calculations. And I'm actually coming away with a more positive note than the headlines suggest.
The bifurcation of the estimated losses into loan losses and mark-to-market losses helps. The former seems relatively straightfoward. It's the latter than presents somewhat of an iota of hope. The losses they are referring are based strictly on where benchmark indices such as the ABX, TABX, CMBX are trading and implying losses on securitized/structured instruments. In other words it is based on the inference of the collective 'feel' of market forces rather than a standalone IMF view on where the actual losses are.
On this point, the report actually noted that there this could be non-representative of the intrinsic quality of the instruments because the market indices may have overshot downwards relative to the quality of the securities (that said, maybe the indices also needs to correct down more).
Also, the losses they refer to on the securitized portions, refer primarily to losses that have been or will be recognized, versus actually realized.
This was based on a quick read, so any thoughts would be very welcome.
Posted by: Francis at April 9, 2008 08:57 AM
You clearly don't know much about equities.
"By all means, dump your money into equities if you think the continuing saga of bad news is "priced in" at an 11 percent decline from the all time high."
The 1270 resistance point, down from the high of 1576, was a 19.4% decline from the peak.
The Forward P/E of the S&P500 on 2008 earnings is currently about 12.7. Certainly not high.
There is at least a 60% chance that the 1270 level of the S&P500 marked a long-term bottom. Of the 40% chance that it will go below 1270, 25% says the bottom will still be above 1200, and only a 15% chance of breaching 1200. Even then, the duration of time it stays below 1200 may be long, but may also only be a few hours.
There is only a 4% chance of the S&P500 going below 1100, ever again.
Posted by: GK at April 9, 2008 02:01 PM
Forward PE at 12...sure, if we see forcast E growing at double digits. Analysts are usually 6-12 months behind, so forget it.
check trailing PE.
i ll play the 4% chance, no problem.
Posted by: nrt at April 10, 2008 06:09 AM
Francis & GK-
You are the voices of reason. I appreciate your comments.
Posted by: Rich Berger at April 10, 2008 08:10 AM
I am not suggesting that we are out of the doldrums by any stretch of the imagination. My point is more that based strictly on implied structured product losses, that the IMF report is not as devastating as the headlines look. That the implied losses may not reflect the real quality (even if low quality) of the underlying assets
All that could very well be less relevant however, compared to the crisis of faith in the banking system which is what is gripping financials today (I think this site posted a very useful marbles analogy earlier)... the effect of which could make things worse (and it likely already has).
Posted by: Francis at April 10, 2008 11:12 AM
Then, by all means, buy puts on SPY, at a level that corresponds with the index breaching below 1100.
I say only a 4% chance, and even then, it would be below 1100 for just days or hours, not months or years.
Posted by: GK at April 10, 2008 11:53 AM
The trailing P/E is currently 13.6.
The 4% chance I give comes with one caveat. If a superdestructive event occurs in the next 60 months, like a nuclear terrorist attack, asteroid impact, 9.0 quake in CA, etc., then it could go well below 1100.
The 'disaster caveat' must be stated.
Why 60 months? Because by 2013, when I predict the S&P500 will have recovered to 2200 or so, is the last time when even a disaster could get us below 1100. After 2013, even 1100 may be too far down for all but the most civilization-crushing events to pierce.
Posted by: GK at April 10, 2008 11:59 AM
Can you ever really let your guard down? The best you can do is weigh the evidence and make your decisions. No sure things.
Posted by: Rich Berger at April 10, 2008 12:24 PM
Agreed. For what it's worth, I think 'Wall St' issues that have dominated the headlines are getting better since the Fed has spent all its time to remedy. It's 'Main St' problems that are coming home to roost now.
Posted by: Francis at April 10, 2008 12:43 PM
I love to find a Bull in the room.
I read a figure that convinced me how bad things are. It was the median income for California for the past 6 years. It started at 64,000 in 2001 and rose to 138,000 in 2006. Then the value fell to 64,000 in 2007. This was due to the income from the housing boom. So you tell me how much that is in losses? Now take those numbers and adjust them across 50 states and add in a few European housing bubbles.
The true numbers will be calculated by someone like Helicopter Ben in 50 years when they are writing a thesis on the subject of the crash of 2008.
So be bullish and optimistic. I'll do what the geniuses that did the Monte Carlo models on derivatives did not do, consider worst case.
Posted by: Hank Jestor at April 13, 2008 01:36 AM