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Credit-Default Swaps May Produce Another Bear Stearns

Back on January 16, 2008, I wrote a post about an article I had read earlier that day by the Washington Post’s Steven Pearlstein. In “Caught in a Downdraft and Starting to Panic,” the 2008 Pulitzer Prize winner talked about the danger from credit-default swaps. He wrote:

Despite the brave exhortations from the CNBC Squawk Box, we are nowhere near the end of the financial unraveling that is necessary for an economic bottom to be reached…

Looking ahead, the final phase of this unraveling is likely to implicate the giant market in credit-default swaps. Those swaps are essentially contracts that allow sophisticated investors to bet on whether a company, a government entity, or even a securitized package of loans will default on its debt obligations. And they can place these bets whether they own the underlying security or not.

Because these contracts trade on unregulated derivatives markets, nobody knows who holds the losing side of the bets. But it’s a good guess that if defaults rise even to historically normal levels, a big hit will be taken by highly leveraged hedge funds, some of which may be unable to pay off on their bets and simply collapse. That, in turn, would trigger even further losses by banks and other investors that, unlike pure speculators, rely on those instruments to insure against default.

The credit-default swap has become so central to modern global finance that its size — the amount insured, in effect — is estimated at $43 trillion. If the losing side is unable to make good on even a fraction of a percent of those contracts, it could set in motion a financial chain reaction that could easily rival the subprime debacle.

Recently, I’ve noticed increased chatter about credit-default swaps in my research. Just today, I came across the following piece by the Wall Street Journal’s Donna Kardos in the MarketBeat Blog. Kardos wrote:

A growing proportion of U.S. firms are seeing credit-default-swap counterparty risk as a serious threat to global markets, and think another major financial company will go under due amid the global-markets crisis, according to a study by research firm Greenwich Associates.

The study’s results, which say the proportion seeing CDS counterparty risk as a serious threat is approaching 85%, highlight the perceived concern of another financial firm going down. Only 27% of the institutions surveyed think there won’t be another casualty along the lines of Bear Stearns, Greenwich consultant Frank Feenstra said in a statement.

The research firm said of the 146 U.S. and European banks, hedge funds and investors it surveyed, most “believe another major financial-services firm will fail as a result of the ongoing crisis in global markets — and they expect it to happen sooner rather than later.”

Almost 60% of the respondents expect another big financial firm will collapse within the next six months, while another 15% see it happening in six to 12 months.

Source:

“Who’s on the Other Side of That Trade, Anyway?”
Donna Kardos
Wall Street Journal (MarketBeat Blog), August 12, 2008

Wall Street, Housing Woes Hit The Hamptons

There goes the neighborhood. I first talked about the Hamptons, the playground for America’s rich on the East Coast, back on June 5 due to a little foreclosure problem they were having. Now, I understand that the east end of Long Island, New York, is having a bigger problem related to home sales and prices. Bloomberg’s Sharon L. Lynch and Laura Marcinek wrote yesterday:

The Hamptons housing market is feeling the heat of Wall Street’s meltdown.

Second-quarter sales volume dropped 29 percent and the median price fell 11 percent to $735,000 from a year earlier in the resort communities on the East End of New York’s Long Island, Suffolk Research Service Inc. said in a report today…

Bloomberg attributes the decline in sales and prices to tough times on Wall Street. According to Wednesday’s piece:

Transactions are dropping as financial firms have cut more than 93,000 jobs and taken more than $416 billion in mortgage- related losses and writedowns. The retreat in global stock markets, waning consumer confidence and the deepening housing recession are also keeping prospective buyers at bay.

Source: L Nichols Woodcarving

Looking at the individual towns, Lynch and Marcinek noted:

In Southampton, the median price dropped 8.6 percent to $891,000. Sales volume fell 35 percent to 257 homes. In East Hampton, prices fell 11 percent to a median of $1,000,000, Suffolk Research said. Volume there fell 40 percent to 120 homes…

In Southold, prices fell 8 percent to $507,500 and sales dropped 19 percent. On Shelter Island, the median price rose 34 percent to $1.13 million, while sales fell 26 percent to 17. The cost to buy in Riverhead also rose, up 9.6 percent to a median of $411,100, while transactions gained 3 percent to 103 properties.

Source:

“Hamptons House Prices Fall Amid Wall Street’s Decline (Update4)”
Sharon L. Lynch, Laura Marcinek
Bloomberg, July 16, 2008

Fund Managers Not Investing In Own Mutual Funds

If I were invested in a mutual fund, I would feel comfortable knowing that the fund manager had a stake in it. MarketWatch’s Chuck Jaffe discovered that this isn’t the case on many occasions. He wrote Monday:

Alas, all too often it’s not and the fund managers don’t have enough belief in what they are doing to actually live by it.

That’s the conclusion to be drawn from a new Morningstar Inc. study which looks at how much managers invest in their own funds… In 46% of the domestic stock funds surveyed, the manager hadn’t invested a dime. Other asset classes were far worse with nearly 60% of foreign stock funds reporting no manager ownership, two-thirds of taxable bond funds having no managers with money in the fund, up to 70% of balanced funds having no manager cash and some 78% of muni bond funds having shareholder cash only.

Ouch. That’s a lot of managers who are going out to eat, rather than eating their own cooking.

Scene From “Blues Brothers” (1980)

It gets worse. Jaffe pointed out:

…if they believe in the product, an investment of no cents makes no sense, especially when the lowest level for disclosure is $1 to $10,000, meaning managers can get credit for 10 grand by simply dropping a buck in their own funds.

Russel Kinnel, director of mutual fund research for Morningstar, told MarketWatch that he believes there’s a direct correlation between investing in a fund and performance. For example, in Morningstar’s fund analysts’ “picks,” the average investment by managers was $370,000, compared with $54,000 for the average analysts’ “pan.” Kinnel noted:

The median picks have an average of $239,000 and $247,000 invested by each manager. Conversely, the median pan has $0 invested.

The Morningstar director offered some great advice to prospective mutual fund investors. Jaffe wrote:

Kinnel said in an interview that manager ownership stakes would not be the first thing to look at in deciding which funds to buy, “but it’s a pretty good indicator of which companies are into stewardship more than salesmanship… If you’re wavering on a fund right now, wondering if you should stick around, and you check and find out that the management is not suffering right along with you, I think you have good reason to be concerned. Those managers are collecting their paycheck, but have decided they are better off investing it somewhere else… and maybe you’d be better off doing that too.”

Source:

“No skin in the game”
Chuck Jaffe
MarketWatch, July 6, 2008

Write Downs, Credit Losses Approach $400 Billion Mark

From Bloomberg yesterday:

The biggest banks and securities firms have booked about $387 billion of writedowns and credit losses since the beginning of last year, as the collapse of the U.S. housing market led to losses on securities tied to the value of home prices.

Source:

“Wachovia’s Thompson Joins Prince, O’Neal Toppled by Subprime”
Peter Robison
Bloomberg, June 3, 2008

Wall Street Strategists Warn Of ‘Credit Recession’ Lasting More Than Two Years

Earlier today, some Wall Street strategists sounded the alarm over a “credit recession” which may last more than two years and result in a massive consolidation of the U.S. financial sector. Reuters’ Jennifer Ablan, Dena Aubin, and Walden Siew reported:

The fallout from deteriorating subprime mortgages and the broader housing and credit crisis will eventually lead to a healthier market, but not until after a prolonged purging process, Jack Malvey, Lehman Brothers Holdings Inc’s chief global fixed-income strategist, said in New York.

“We’re going through a tough spell with regard to credit,” Malvey said at a Securities Industry and Financial Markets Association conference.

The “subprime debacle” due to years of excess and easy credit will be followed by years of tight credit, Malvey said…

“This is the biggest blowup that we’ve had,” the strategist said.

Richard Bernstein, chief investment strategist at Merrill Lynch, told Reuters that in the last market cycle downturn, about 25% of financial firms (including brokers, banks, and asset managers) “went away,” referring to bankruptcies or mergers and acquisitions. To date, only 7% of financial firms have suffered this fate. He was also critical of proposed remedies for the housing crisis. From the Reuters piece:

Bernstein also faulted U.S. government proposals to broadly modify U.S. mortgages, which may create a “moral hazard” that encourages future risky behavior, he said.

“Washington is misguided in focusing on mortgages,” Bernstein said. The federal government should focus on “job creation and people keeping their jobs,” Bernstein said. “That is the key to rectifying this situation.”

Source:

“U.S. subprime debacle may spark 2-year credit recession”
Jennifer Ablan, Dena Aubin, Walden Siew
Reuters (India), June 4, 2008

For Whom The Bell Tolls, Part 3

Aaron Elstein of Crain’s New York Business is a no nonsense kind of guy. Last Friday, Elstein began a piece on Wall Street layoffs with the following sentence:

In the past year, 22,000 New Yorkers who work on Wall Street have lost their jobs, according to a Crain’s estimate. And far more blood-letting is to come.

No sense beating around the bush, right? Anyway, the following is a tally of announced pink slips over the past year, total worldwide followed by estimated number in New York City (in parentheses):

CITIGROUP- 15,900 (3,000)
BEAR STEARNS- 9,200 (7,000)
UBS- 7,000 (1,000)
LEHMAN BROTHERS- 6,400 (2,000)
MERRILL LYNCH- 5,200 (2,000)
MORGAN STANLEY- 4,400 (2,000)
J.P. MORGAN CHASE- 4,100 (1,500)
BANK OF AMERICA- 3,700 (1,000)
GOLDMAN SACHS- 1,500 (500)
WACHOVIA- 1,400 (1,000)
CREDIT SUISSE- 1,300 (750)
DEUTSCHE BANK- 500 (250)
—
TOTALS- 60,600 (22,000)

Elstein noted:

Though cuts have been worst in such hard-hit areas as mortgages and structured finance, bankers in more traditional lines like initial public offerings and advising on corporate mergers and acquisitions now seem vulnerable. IPO volume is down nearly 70% this year, according to Renaissance Capital in Greenwich, Conn., and M&A activity is off nearly 40%, according to Bloomberg data.

The Crain’s reporter also painted a grim picture for aspiring Wall Street players. Elstein wrote:

The city’s Independent Budget Office forecasts that 33,300 Wall Street jobs—17% of the city’s best-paid workforce—will disappear by next year. The IBO estimate, which reflects a 65% increase over the previous projection, approaches the 40,000 local jobs that were slashed when the technology bubble burst earlier this decade.

Source:

“22,000 jobs cut, with more to come”
Aaron Elstein
Crain’s New York Business, May 31, 2008

Merrill Lynch, Morgan Stanley Issue Recession Warnings

At a conference yesterday in Singapore, New York City-based financial services giant Merrill Lynch warned the U.S. economy is in a recession that will become more apparent as the year drags on. According to Channel NewsAsia yesterday:

Merrill Lynch said the world’s largest economy is already in a recession, and it expects to see a prolonged L-shaped recovery. This means the US may take a longer time to emerge from the economic doldrums….

Merrill Lynch said a key indicator of a recession is a slump in the housing market. It added that it expects the housing market in the US will see another 15-20 percent downside.

Staff from the firm said that government efforts to provide stimulus to the economy will only temporarily stem a fall in consumer spending, according to Reuters’ Kevin Lim. Merrill Lynch’s North American economist David Rosenberg told conference attendees yesterday:

I still maintain the business cycle is bigger than the government.

Rosenberg also predicted inflation in the United States would slow as consumer spending weakens, and that the Federal Reserve would cut interest rates to fight the recession. The economist warned:

No asset class security is priced today for a recession scenario.

Adding their two cents, economists from Morgan Stanley are concerned that the recession in the United States could rival the “the big five,” according to David Gaffen from the Wall Street Journal’s Market Beat blog today. Gaffen explained the “big five” were large-scale financial crises that resulted in a long-term underperformance in the respective economies. He wrote:

The long-term declines the firm looks at includes Spain in 1977 and Norway in 1987, and most recently Japan in 1992 – which they define as the worst, resulting in Japan’s so-called lost decade. Whether the current U.S. economic decline matches one of these situations, or looks more like the recent U.S. recessions “holds the key for risky asset prices,” they write.

However, Morgan Stanley economists do not agree with their Merrill Lynch counterparts when it comes to the topic of inflation. From the Market Beat post:

Morgan Stanley economists say that in this instance, inflation may not automatically recede as U.S. growth recedes. They say as a result that bonds may sell off if growth recovers in the U.S. and monetary policy remains loose, fueling price gains… “We believe that the Fed’s focus on keeping the financial crisis from sending the economy down the path of the Big Five will succeed, but lower rates and surging money growth will spill over into inflation. Bond yields are likely to follow inflation higher,” they write.

Sources:

“Merill Lynch says US in recession, but Asia to remain strong on consumer spending”
Channel NewsAsia (Singapore), May 14, 2008

“Tax rebate won’t stem U.S. recession: Merrill”
Kevin Lim
Reuters, May 14, 2008

“Regular Recession, or a Larger Disaster?”
David Gaffen
Wall Street Journal (Market Beat blog), May 15, 2008

Wall Street Could Say ‘Sayonara’ To 36,000 Jobs

Time to dust off those resumes, Wall Streeters. According to James Brown of the New York State Department of Labor, Wall Street could lose over 36,000 jobs due to the housing bust, subprime mortgage meltdown, and credit crunch. Earlier today Brown, a labor market analyst, told Reuters that regarding his forecast of one in five jobs being eliminated, “History suggests it’s going to be something of that magnitude.” Reuters’ Joan Gralla wrote that Brown’s estimate “was almost double the 20,000 job loss over the next two years that the city’s Independent Budget Office forecast in March.”

At the end of March, 182,300 people were working at banks and brokerages, down more than 5,000 since September. According to Brown, the small number of layoffs seen so far likely reflects the lag between the end of severance payments and when job hunters file for unemployment benefits.

Source:

“Wall St may lose 36,000 jobs”
Joan Gralla
Reuters, April 24, 2008

Economists Predict 6% Jobless Rate, 2 Million Lost Jobs

Earlier today I read an interesting article that discussed the U.S. employment outlook and which jobs may or may not be good bets in a deteriorating economy. Martin Crutsinger of the Associated Press wrote:

While the downturn is expected to be short and mild, economists are still forecasting the unemployment rate, which jumped to 5.1 percent in March, will climb much higher before the nation’s job engine sputters back to life.

Economists are forecasting a jobless rate that will peak at around 6 percent, but probably not until early next year, several months after the recession is expected to end. Analysts said as many as 2 million people could lose their jobs in the current downturn.

Mark Zandi, chief economist at Moody’s Economy.com, said:

All the indicators suggest that we will see even larger job declines in coming months. Businesses are getting nervous and pulling back.

“Safe” Jobs:

• Healthcare
• Education
• Farming
• Some manufacturing (airplanes, heavy machinery)
• Government

“Unsafe” Jobs:

• Other manufacturing (automakers, housing-related like appliances, furniture)
• Construction
• Housing-related industries (real estate agents, mortgage brokers)
• Wall Street firms
• Discretionary services (tourism-related)

Source:

“Job winners and losers in hard times”
Martin Crutsinger
Associated Press, April 7, 2008

Report: U.S. Commercial Banking Industry To Shed 200K Jobs

According to the Associated Press this afternoon, analysts at the financial research firm Celent LLC reported today that it expects the U.S. commercial banking industry (all companies that lend/collect deposits) to lose 200,000 of its 2 million jobs over the next 12 to 18 months. AP business writer Madlen Read wrote:

Octavio Marenzi, the head of Celent’s financial consultancy unit, said more layoffs are inevitable as the subprime crisis hits other parts of the banking industry and spreads beyond mortgages to mortgage-related products, such as home-equity loans, and other types of lending, such as credit cards.

“The banking industry over the past 40 years has never seen a downturn in its revenue growth,” Marenzi said. “In 2008, it looks like it will decrease for the first time in living memory. They’re going to have to respond with severe cost cutting. It’s not an environment they’re entirely used to.”

Read noted that Celent’s estimate does not include the securities industry and its 800,000 employees, which is at its highest employment level ever due to a multiyear hiring spree.

On the prospect of more lost banking jobs, John Challenger of the Chicago-based outplacement consulting firm Challenger, Gray & Christmas told the Associated Press:

There’s no horizon yet that anybody can see. New events keep rolling out… suggesting that there’s more to come…

What we haven’t seen are big mega-layoffs — tens of thousands of people in a large company. It just feels to me there are big ones coming.

Source:

“Celent: 200,000 US Banking Jobs at Risk”
Madlen Read
Associated Press, April 1, 2008

UBS Predicts $600 Billion Loss From Credit Crunch

On Friday it was reported that analysts from UBS AG, Europe’s second largest bank, were predicting total industry losses from the ongoing credit crunch would reach $600 billion, with banks and brokers accounting for $350 billion of these losses. MarketWatch’s Steve Goldstein said earlier today that financial firms have been forced to write-down approximately $160 billion since the crisis began last summer. Goldstein wrote that, according to UBS strategist Geraud Charpin’s note to clients:

Corporate collateralized debt obligation have been relatively spared because defaults are low and CDOs are not mark to market, but risks remain, particularly as monoline insurers are heavily referenced in CDO baskets.

In today’s “Daily Briefing,” Fortune’s Colin Barr noted that:

The comment comes a day after insurance giant AIG (AIG) took an $11 billion hit on its portfolio of credit default swaps and government-sponsored mortgage lender Freddie Mac (FRE) took $3.1 billion in writedowns on its credit guarantee and derivatives holdings. UBS itself was hit with a $14 billion writedown on mortgage-related securities earlier this month…

“Leveraged risk positions are a cancer in this market, wrote UBS analyst Geraud Charpin, “and the sooner it is treated the better.”

According to CNN Money, the world’s largest manager of private wealth assets is concerned most underestimate the impact of the credit crunch:

The bank also noted that the crisis’ impact on the real economy is likely to be stronger than currently expected.

‘To cut a long story short, if we had a ‘rhetoric index’ measuring the tone of messages from our economics team, it would have been dropping since last September,’ the study said.

UBS said the downward trend has accelerated over the last few months with both US and EU data becoming increasingly worrisome.

‘At this stage, therefore, we have to recognise the risk that the economy will suffer more damage than what consensus suggests,’ UBS said.

No Sympathy For Wall Street

“Shanna, they bought their tickets, they knew what they were getting into. I say, let ‘em crash.”

-Airplane! (American comedy film. 1980)

I have this strange feeling that Washington Post columnist Steven Pearlstein is not Wall Street’s biggest fan. Maybe it has something to do with his piece from this morning entitled “Time for Wall Street to Pay,” in which he wrote:

I’d be lying if I didn’t admit there’s part of me that takes some perverse satisfaction from the ever-widening crisis that has engulfed Wall Street, humbling its most powerful institutions and exposing its hypocrisy and corruption.

Pearlstein was just getting started:

Over the ensuing two decades, Wall Street has been brilliant at dreaming up other financial innovations that picked up where junk bonds left off. These included complex futures and derivatives contracts; loan syndication; securitization; credit default swaps; off-balance-sheet vehicles; collateralized debt obligations, or CDOs; and blank-check initial public offerings.

As the industry and its cheerleaders constantly remind us, these innovations have helped to lower the cost of capital and make the business sector more efficient and globally competitive. But what we are now discovering — or perhaps rediscovering — are all the ways in which all this glorious financial innovation has weakened the economy and the society it serves.

Pearlstein listed how Wall Street’s “innovations” have taken their toll on America and its economy:

For starters, these innovations have helped to create a cycle of financial booms and busts that have a tendency to spill over into the real economy, contributing to a heightened sense of insecurity.

They have shortened the time horizons of investors and corporate executives, who have responded by under-investing in research and the development of human capital.

They have contributed significantly to massive misallocation of capital to real estate, unproven technologies and unproductive financial manipulation.

They have made it easy and seemingly painless for businesses, households and even countries to take on dangerous levels of debt.

They have given traders a greater ability to secretly manipulate markets.

They have given corporations clever new tools to hide risks, liabilities and losses from investors.

And by giving banks the tools to circumvent reserve requirements and make more loans with less capital, they have enormously increased the leverage in the financial system and with it the risk of a financial meltdown.

But far and away the greatest damage from all this financial wizardry is the obscene levels of compensation it has generated for a select group of Wall Street executives and money managers.

Regarding this last point, Pearlstein warned that because “huge bonuses paid in the good years are never required to be paid back in the bad years,” this creates an “asymmetric compensation system that encourages excessive leverage and risk-taking.” Furthermore, he lamented at the fact that the prospect of earning untold wealth on Wall Street has attracted “an enormous amount of young talent that could have been more productively used in science, engineering, medicine, teaching, public service and businesses that generate genuine long-term value.” He asked:

Is it not fair to ask whether the United States can remain the world’s most prosperous and innovative economy when half of the seniors at the most prestigious colleges and universities now aspire to become “i-bankers” at Goldman Sachs?

At which point, Pearlstein went nuclear:

So I hope you’ll forgive me, dear readers, when I say that the best thing that could happen to our economy is for a dozen high-profile hedge funds to collapse; for investment banking to enter a long, deep freeze; for a major bank to fail; and for the price of a typical Park Avenue duplex to fall by 30 percent. For only then might we finally stop genuflecting before the altar of unregulated financial markets and insist that Wall Street serve the interest of Main Street, rather than the other way around.

Yes, I know it’s harsh and vengeful solution, and there will be lots of collateral damage. But as I look out over the destruction sweeping across the financial sector, I just can’t silence the small voice in my head that keeps repeating that old ‘60s expression, “Burn, baby, burn.”

There’s Always Grad School

It was Spring 1993. I was in college, and had just returned from a night out with a girl I’d been seeing. I asked Laura what her plans were after graduation. She reminded me, “I’m a marketing major. I know, I won’t be getting any job offers, so don’t laugh.” She was referring to the terrible job market at that time- the result of a recent recession whose effects were still being felt. Things were so bad that a campus bar was giving away a free party to the student who had the most “bong” (rejection) letters from employers. Quite a few graduates, faced with the prospect of unemployment, decided to extend their academic career and attend graduate school instead.

On Sunday, MarketWatch talked about a new report from the Center for Economic and Policy Research (CEPR), which said up to 5.8 million additional workers in the United States could join the ranks of the unemployed by 2011 if the U.S. economy entered into a severe recession. In the case of a mild to moderate recession, lasting 6 to 9 months, CEPR is projecting an additional 3.2 million unemployed by 2010. At the end of 2007, there were already approximately 7 million unemployed Americans. Even after the recession formally ended, the Washington D.C.-based think-tank predicted the labor market would still be in bad shape. John Schmitt, CEPR senior economist and co-author of the report, said:

The financial markets are basically sending an enormous storm over the economy. Even when the sun comes out, there will still be the devastation left behind. The hiring will resume at a rate slower than before, and with a big backlog of workers that are unemployed.

Signs of unease are already starting to show up on America’s college campuses. Earlier today, Sarah Conway of the Washington Square News (New York University’s student newspaper) wrote:

As economic fears loom over the U.S. market, students set to enter the job market are wondering who will be left out in the cold… And the volatile economy has left some NYU students wondering what the future holds for soon-to-be graduates.

Conway pointed out that NYU’s Wasserman Center for Career Development, one of the 50 largest career centers in the U.S., was exceptionally busy this past winter break. Trudy Steinfeld, executive director for the Center, told the reporter:

This is an office that is rarely slow, but this was the busiest break. We saw more students than we ever had. And the students were coming in very stressed.

Steinfeld believed the stress was linked to anxiety from potential family financial pressures, as well as concerns about the U.S. economy. A slowing economy is particularly worrisome to NYU graduates, said Lawrence J. White, a Stern professor of economics at the university. He noted, “It has a special relevance for NYU graduates because many students go into financial services, and it has been hit especially hard.”

Jessica Alexander, Senior Staff Reporter for the Crimson White, a University of Alabama publication, also talked about student concerns over a recession. Alexander wrote on January 28:

Some students said they are concerned that the flailing economy and mass job cuts may affect them when they graduate.

Courtney Howell, a junior majoring in English, said many of her friends last year complained about the job market after they graduated, but now she is worried about her future job.

“If people keep getting laid-off and the job market keeps becoming more competitive and crowded, I don’t think I will be able to get my dream job,” Howell said.

Still, a number of college students aren’t too concerned about the prospect of an economic slowdown. Davida Carson, a freshman majoring in interior design at the University of Alabama, told the reporter:

People just need to continue buying things and living their lives. That’s how we get a healthy economy.

Freshmen…

Banks May Write Down Additional $300 Billion

Yesterday, global strategy consulting firm Oliver Wyman said in a new study that an additional $300 billion in write-downs related to the U.S. subprime mortgage meltdown may be announced by banks before the crisis is over. Back on January 18 I noted that write-downs had already surpassed $100 billion. In a press release picked up by Yahoo! Finance yesterday, John Colas, Managing Director and head of the North American Corporate Strategy Practice at Oliver Wyman, said:

The credit crisis is unlikely to resolve itself before the end of this year. We also see strong likelihood of price corrections in emerging markets and this combination will extend the value loss and turbulence witnessed in 2007.

The management consultancy said in its “State of the Financial Services Industry” report:

We expect a stormy 2008. While governments, central banks and regulators scramble to address the aftermath of the sub-prime fallout, several other crises are mounting.

These other disruptions include:
• A significant slowdown in European real estate markets, especially in Spain and the UK
• The continued weakening of the U.S. dollar
• A collapse in commodity prices
• A fall in Chinese and Indian stocks

The financial services industry should expect “turbulent conditions for 2008 and beyond.” Oliver Wyman predicted that American banks are especially at risk. From its 2008 report:

North American financial services firms will have a tough year. Market uncertainty, combined with further write-downs and expected home-price and loan-volume declines, implies more squeezes on earnings. Banks most likely will have to increase loan-loss reserves.

In North America last year, the financial sector lost 13% in market value, second only to Japan. In contrast to the United States, the value of financial companies in Canada grew 12%.

For the first time since 2002, the global market value of the industry fell, according to the annual report. Controlling for exchange rates, the industry lost 7% of its market value last year. While $300 to $400 billion was gained in red-hot emerging markets last year, financial institutions lost more than $1 trillion in mature economies.