A popular radio show from the 1940’s, “Can You Top This?”, was one of my Mom’s favorites when she was a kid. In the program, comedians swapped jokes while a “laugh-o-meter” gauged the audience response to see who was the funniest. This was the pre-TV version of "America’s Funniest Home Videos", a show that my kids just can't get enough of today.
Well the subprime credit crunch is no laughing matter, and I think it's safe to say we've all had our fill of hearing about it. But analysts and economists are playing a similar “Can You Top This” game. They're trying to out-do each other with the biggest credit loss estimates imaginable. All we need is a “fear-o-meter” to gauge investor’s shock to these various estimates.
This week the International Monetary Fund weighed in with perhaps the most dismal loss estimates yet. According to the IMFs numbers the subprime credit crunch may result in $945 billion in expected losses and asset write-offs world-wide. Now who’s gonna top that?
The Worst Financial Disaster in History!
Global financial firms have reported about $230 billion or so (and still counting) in credit crunch losses so far. So the IMFs data implies that the financial “pig” isn’t even one-quarter of its way through the credit crunch “python” yet!
If proved correct, the U.S.credt crunch would easily become the costliest financial crisis in history.
The previous holder of this dubious distinction is Japan, which suffered about $750 billion in total losses during its “lost decade” of the 1990’s. In fact, the current subprime loss estimates make the U.S. Savings & Loan crisis of the 1980s and early ‘90s look like a drop in the bucket by comparison. That episode triggered losses of about 4% of U.S. GDP at the time. Today’s IMF estimate puts the total hit at about 7% of GDP.
More than half of the IMFs loss estimate – equal to some $500 billion – will be suffered by the banking sector. These hits are mainly confined to the U.S. and Europe where asset-backed securities proved to be the most popular (and toxic).
The “Mark-to-Market” Fudge Factor
There’s a very large “fudge factor” in the IMFs calculations however. About 76% of the total, or $720 billion in estimated losses, will come from asset-backed securities of different kinds.
To arrive at that number, the calculations are based on distressed mark-to-market prices the IMF observed in mid-March… before the Fed’s “arranged marriage” of Bear Stearns with JP Morgan.
These distressed market prices for toxic asset backed paper may prove too pessimistic (along with the IMFs loss estimates) if credit markets are able to recover. In the wake of the Bear Stearns deal, and since the Fed is now willing to accept a wider range of securities as collateral for direct loans to banks, credit conditions seem to be easing.
Interest rate spreads on Credit Default Swaps for U.S. banks, which are basically insurance policies against another Bear Stearns like debacle, have fallen by as much as 40%. This means there is now less perceived risk in the financial sector. At the same time however, key short term lending rates, such as interbank LIBOR rates, remain uncomfortably high.
How Much of This $1 Trillion is Already “Priced Into” the Market?
The financial system is certainly not out of the woods just yet, that’s for sure. You can expect to see more shocking losses and asset write-offs from big banks over the next several weeks as first quarter reports are posted. It’s important to watch how markets react – financial shares in particular – to these announcements.
Remember, when stocks stop going down further on bad news, that’s the first sign that the worst may have already passed. When stocks actually go UP on more bad news, that’s a strong indication investors are looking beyond the gloomy headlines, and toward a recovery.
We may not be at that point just yet, as today’s market slide will certainly attest. But we may be getting closer. The IMF says: brace yourself for one-trillion dollars in subprime losses… can you top that?
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