Recent declines by US and European financials combine with falling house prices, credit and consumer demand to add to overall economic turmoil, writes Proinsias O'Mahony
GLOBAL FINANCIAL writedowns are now within touching distance of half a trillion dollars after a slew of multibillion dollar writedowns in America and Europe yesterday.
In the US, insurance giant AIG lost 11 per cent in early trading after announcing its third consecutive quarterly loss of more than $5 billion (€3.25 billion). It wrote down $5.56 billion in credit default swaps - guarantees sold to fixed-income investors. AIG has suffered writedowns in the region of $25 billion over the last nine months, despite earlier protestations of recently ousted CEO Martin Sullivan that any losses would be "manageable".
The losses have forced AIG to raise approximately $20 billion through selling shares and other securities and yesterday's figures caused some analysts to speculate that further capital raisings may be necessary.
Writedowns were also the order of the day in Europe, with Barclays, German bank Dresdner Kleinwort and Belgian financial services firm KBC announcing more than $5 billion in writedowns between them.
Estimates of total writedowns have increased steadily as the credit crisis continues to dog financial firms. Last month, the International Monetary Fund (IMF) re-iterated its April call that total credit losses would approach $1 trillion. Others are even more pessimistic, with hedge fund manager John Paulson predicting $1.3 trillion in losses while a recently leaked report by influential hedge fund Bridgewater Associates arrived at a figure of $1.6 trillion.
Many observers have speculated that Paulson, whose Credit Opportunities fund returned an astonishing 590 per cent last year after he correctly bet on a collapse in the US subprime market, was preparing to call a bottom for financials.
In July, it emerged he was preparing a fund to invest directly in cash-strapped banks. However, he said this week that the recent gains in financial stocks would be "short-lived".
"We expect that the negative effects of continued home price declines and contracting credit will lead to a decline in consumer spending and, in turn, a decline in US GDP ," he said in his second-quarter report to investors.
"As the economy weakens, we expect credit costs will continue to rise, resulting in weaker financial earnings, the need for additional capital and lower stock prices for financials."
Paulson is not the only heavy-hitter to be concerned. In a Financial Times article this week, former Federal Reserve chairman Alan Greenspan wrote that "there may be numbers of banks and other financial institutions that, at the edge of defaulting, will end up being bailed out by governments". Greenspan described the financial turmoil as a "once or twice a century event deeply rooted in fears of insolvency of major financial institutions", with a stabilisation in US housing prices key to resolving the "insolvency crisis".
He expects the current housing "inventory glut" to ease "later this year", although he cautions that this is based on an assumption that "current levels of demand for housing hold up".
Critics might note Greenspan wasn't always so concerned. In 2005, he praised the "constructive innovation" in the subprime mortgage market. "
Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately," he said, adding subprime lending was "both responsive to market demand and beneficial to consumers".
One man who has been concerned for some time is Jeremy Grantham, the legendary fund manager who manages more than $150 billion in assets and who last summer warned that the "overstretched, overleveraged financial system" was a "slow-motion train wreck".
Grantham was criticised as a doomsayer for predicting that the "first truly global bubble" in asset prices would cause "one major bank" to fail.
Far from being overly pessimistic, Grantham last week said that his earlier predictions were "positively quaint" and that he "underestimated in almost every way how badly economic and financial fundamentals would turn out".
"In 2000, we had a technology bubble. But this is massive, a massive credit crisis and a bubble in global housing, global equity and global land."
Grantham says he is now "officially scared", recommending investors go to cash and "live to fight another day".
Financial companies are not the only ones left out of pocket as a result of the ongoing financial turmoil.
According to the Wall Street Journal yesterday, a report by Swiss bank UBS says the US government has provided nearly $1 trillion in funding to banks, making it the most expensive financial crisis in world history. That dubious honour was previously held by the Japanese government, which had to fork out $600 billion to banks during its financial crisis in the 1990s.
Measured as a proportion of GDP, however, the current crisis is dwarfed by the Japanese experience - US support is 6.9 per cent of GDP, as opposed to Japan's 13 per cent.
Despite the massive government support, UBS cautions further government intervention will be necessary, with shareholders and sovereign wealth funds unlikely to continue to pony up cash for underperforming investments. Although US and European banks have already raised $265 billion, UBS expects financials to require a further $75 billion as credit costs increase.
