2008 is set to be the darkest ever year in financial history according to Goldman Sachs – a new report claims.
The Times reports that the credit crunch is so serious that it may force the US banking system to cut lending by as much as $4,000 billion, prompting a “substantial recession” in the US.
As much as $400 billion could be wiped out from the US banking system prompting fears that the knock-on effect could spell an economic catastrophe on both sides of the Atlantic.
The mass of defaults on high-risk home loans in America has emerged in greater detail over the last 3-4 months but more and more banks and lending institutions are having to own up to the full extent of their losses as the financial world is being rocked to it’s core with the sheer scale of the financial melt-down.
Mr Jan Hatzius, chief economist at Goldman Sachs estimates that with every $1 dollar in losses, equates to the inability of highly leveraged Wall Street lending by $10, as they typically aim for a so-called capital ratio of 10 per cent.
“If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion,” Mr Hatzius said.
Mr Hatzius’s actual prediction of a $400 billion write-off would reduce lending by $4,000 billion.
“The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognised. It is easy to see how such a shock could produce a substantial recession,” Mr Hatzius said.
“While the uncertainty is huge, the associated downward pressure on lending raises the risk of significant weakness in economic activity.”
Goldman’s forecast predicts further disastrous consequences for global economy, sighting numerous factors such as the cost of the war in Iraq, record oil prices, sub-prime defaults and growing unemployment.
“The potential for an economic implosion and subsequent world recession is huge and could surpass the biggest financial crash in history of that of the Great Depression”.
Billions were wiped off the world financial system in the 1920’s / 30’s. This period was known as ‘The Great Depression’ (also known in the U.K. as the Great Slump). This was the most dramatic of worldwide economic downturns in history.
It all started with the stock market crash on October 29, 1929, known as Black Tuesday. The depression had devastating effects in both the industrialised countries and those which exported raw materials.
With similar beginnings to the current crisis, the Great Depression was not a sudden total collapse but more of a slow burning fuse that sparked a sequence of major financial catastrophes across the US and subsequently around the globe.
The stock market had suffered losses due to the October 1929 crash – not too dissimilar to the Northern Rock and the Sub-Prime mortgage crisis of today.
Having faced severe losses from the initial crash, consumerism plunged dramatically and a severe drought ravaged the agricultural heartland of the USA beginning in the summer of 1930.
Credit was ample and available to sub-prime borrowers at low rates and few were reluctant to avoid borrowing. By May 1930, vehicle sales had declined to below the levels of 1928. Oil prices had risen sharply while retail values in general began to decline.
Wages began to drop in 1931. Conditions were worst in farming areas where commodity prices plunged, and in mining and logging areas where unemployment was high and there were few other jobs. The decline in the American economy was the motor that pulled down most other countries at first, then internal weaknesses or strengths in each country made conditions worse or better. By late in 1930, a steady decline set in which reached bottom by March 1933.
Many experts and scholars believe that it was the fault of governments and the banking institutions who were to blame for the great depression. It was said that the problems began with excessive lending and a blatant disregard for cheap loans.
Massive bank failures were largely to blame for the great depression and the stock market crash of the 1930’s, huge layoffs occurred, resulting in unemployment rates of over 25%. Banks which had financed a lot of bad debt began to fail as debtors defaulted on debt and bank depositors became worried about their deposits and began massive withdrawals.
Government guarantees and Federal Reserve banking regulations to prevent these types of panics were ineffective or not used. Bank failures led to the evaporation of billions of dollars in assets. Up to 40% of the available money supply normally used for purchases and bank payments was destroyed by all these bank failures.
By 1933, depositors saw $140 billion of their deposits disappear due to uninsured bank failures. Bank failures snowballed as desperate bankers tried calling in loans which the borrowers did not have time or money to repay. With future profits looking poor, capital investment and construction slowed or completely ceased. In the face of bad loans and worsening future prospects, the surviving banks became even more conservative in their lending. Banks built up their capital reserves, which intensified deflationary pressures. The vicious cycle developed and the downward spiral accelerated. This kind of self-aggravating process may have turned a 1930 recession into a 1933 great depression.
There are frightening similarities in the current situation in the US and in Britain. Once again, a banking crisis is threatening to undermine a global economy. Banks are too late in tightening the credit purse strings. There will be no more easy money, on the contrary, there will be very little money at all – and even the regular credit cards, bank overdrafts and small loans will be harder to get hold of as there simply is no money to lend out.
In addition to making it much harder to secure a mortgage or loan, such a dramatic decline in lending would hamper the ability of consumers to borrow money to finance smaller purchases such as cars, televisions and washing machines.
Since two-thirds of the US economy is driven by consumer spending, this will hit retailers and other companies particularly hard. Businesses will also be deterred from borrowing money to invest and will be less able to stave off looming redundancies, putting further pressure on the US economy.
Goldman’s prediction comes after Wall Street firms such as Citigroup, Merrill Lynch and Morgan Stanley have collectively reported more than $50 billion in losses on investments related to sub-prime mortgages.
It follows the US Federal Reserve’s second cash infusion of the month on Thursday, when it injected $47.25 billion into the financial system, the largest since the terrorist attacks of September 11, 2001 .
The latest injection was administered two weeks after the Fed injected $41 billion, as the fallout from the housing crisis gathered momentum.
There is no end in sight and with other countries economies clearly suffering in tandem with the US, there is growing fear that this could be the mother of all recessions.