Goldman Sachs States Credit Losses Could Cut Lending by $2T

Credit losses amongst the banks may result in a reduction of lending by $2T. Personal opinion is that the $2T decrease in lending is a fairly conservative number. Because of the leverage (total liabilities divided by net worth in its simplest form) used by most banks if you lose $1 of equity you may lose $10 of liabilities, which reduces a bank’s ability to lend. Text in bold is my emphasis. From Bloomberg:

Goldman Sachs Group Inc., the largest U.S. securities firm by market value, said losses from slumping credit markets may reduce lending by $2 trillion.

Losses related to record U.S. home foreclosures using a ``back-of-the-envelope'' calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief economist at Goldman in New York, wrote in a report. The effects will be amplified as banks and hedge funds that borrowed to finance their investments scale back lending, according to the report.

``The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized,'' Hatzius wrote. ``A $1 mortgage credit loss could result in a reduction in lending by significantly more than $10.''

Citigroup Inc., the biggest U.S. bank, and Merrill Lynch & Co. have led companies writing down more than $50 billion on securities linked to U.S. subprime mortgages. Wells Fargo & Co. Chief Executive Officer John Stumpf said yesterday that the worst U.S. housing market since the Great Depression may mean ``elevated'' equity losses through 2008.

Goldman's Hatzius said his report is based on a ``conservative estimate'' of investors cutting lending by 10 times the loss to their capital. Investors realizing half of the potential losses, at $200 billion, would have to scale back lending by $2 trillion, he said.

Goldman's U.S. economic forecasts already assume lending will fall by $1 trillion over the next two years, or half of the potential loss to the economy, the report said. The New York-based bank expects U.S. growth to slow to 1.9 percent in 2008, less then the 2.4 percent median forecast of 70 economists surveyed by Bloomberg News this month.

Deutsche Bank AG, Germany's biggest bank, also said in a report this week that credit losses may be $400 billion. That's equivalent to ``one bad day in the stock market,'' or 2.5 percent of the value of U.S. equities, Hatzius wrote.

``No serious analyst would argue that a 2.5 percent equity market decline will make an important difference to the economic outlook,'' Hatzius wrote. ``So what's different about the mortgage credit losses? In a word, leverage.''