More banks brace for subprime spanking
Bank of America, which had already announced a write-off associated with subprime loans, also disclosed that its fourth-quarter earnings would suffer from the collapse in the credit markets.
Other financial institutions that warned investors Friday of further trouble ahead included Wachovia, which reported a $1.1 billion decline in the value of its subprime holdings, and E-Trade, which said it would not meet its previously announced earnings targets.
Things have gotten so bad that investors are punishing financial services companies merely on the suspicion that they might be underestimating the losses associated with subprime. That was the case with London-based Barclays on Friday, which had to deny rumors that it would announce a $10 billion loss. Its stock rebounded from a 5 percent loss to close down 2.4 percent in London, but the fluctuation highlighted the prevailing skittishness toward financial services stocks.
Jack Malvey, chief fixed income strategist at Lehman Bros., says the current crisis had already eclipsed that last big credit crunch, when Long-Term Capital Management imploded in 1998. "Collectively, we use the 1998 analogy as our pattern," Malvey says. "It lasts two to three months, and it's done. That has proven fallacious."
Instead, Malvey points to the financial crisis of 1987 as a more accurate barometer of what's happening today. That credit crisis affected bank lending for several years. "This is phase two of a three-phase process," Malvey says. "The patient will recover, but our big vigilance will be two, three and four quarters out." By then, he says, it will be clear whether the country is headed into recession.
Ever since Oct. 24, when Merrill Lynch announced that the write-off it would take related to subprime mortgages was $7.9 billion - well over the $4.5 billion it announced earlier in the month - investors in bank and brokerage stocks have exhibited a short fuse.
The situation became worse in early November when Citigroup announced that its subprime losses could swell to $10 billion and beyond. Its problems have knocked nearly $100 billion from its market value in six months. Other banks, including Bank of America, have also come under intense scrutiny. Last week, Morgan Stanley announced a $3.7 billion write-down. So far, the CEOs of Merrill Lynch and Citigroup have lost their jobs in the subprime washout.
While Citigroup and Merrill Lynch have sustained the most damage so far, the nation's biggest banks and brokerage firms are all at risk for some kind of haircut - both in the near term and into 2008. The reason: The amount of losses attributed to collateralized debt obligations are impossible to quantify because they depend on what happens with the economy and whether the Federal Reserve, which has been cutting interest rates to free up liquidity, reverses course.
"We're really at a precipice," says Kris Niswander of SNL Financial. "The value of the dollar is dropping, we have strong employment numbers and inflationary pressures still exist. If the government starts raising interest rates ... we're going to see this unwind further."
Christopher Flanagan of JPMorgan Chase predicts even greater losses, for residential and commercial mortgages, of $200 billion to $250 billion. So far, he says, $30 billion to $40 billion has been recognized in earnings statements from banks and brokerage firms.
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