Wednesday, April 23, 2008

Subprime Crisis Far From Over

Banks' Credit Crisis Over? Not So Fast
By Rachel Beck
Associated Press

Bank CEOs missed the mark in forecasting the destructive path of today's credit crisis. That's why we shouldn't take too seriously their predictions that it is almost over now.

Some of Wall Street's biggest names have been proclaiming in recent weeks that the worst of the financial market turmoil is likely done. JPMorgan Chase's Jamie Dimon thinks it is "maybe 75 percent to 80 percent over," while Goldman Sachs' Lloyd Blankfein says "we're closer to the end than the beginning."

Those kind of comments helped put a positive spin on what otherwise would have been a tough earnings season for financial companies, which have tallied massive losses as mortgage and other debt woes continued to weigh on their businesses.

It's in the CEOs' best interests to steer sentiment higher. If people feel better about the state of the economy or financial markets, that will lead to more deals or stock trading and will boost bank profits.

The data don't back up their happy views, however. We're still stuck in a painful housing downturn, mortgage defaults continue to soar, and rising inflation is hurting businesses and consumers.

The credit crisis has led to more than $200 billion in write-downs taken by banks and financial firms over the last year — far more than anyone had expected, given the optimism of those companies' CEOs last summer.

As the housing market contraction accelerated and subprime borrowers were increasingly defaulting on their home loans in the first part of 2007, those executives were telling us not to worry.

Last June, Bear Stearns CFO Sam Molinaro talked about how the high level of subprime mortgage defaults hadn't "spilled" into other areas of the market. Merrill Lynch CEO Stan O'Neal said the subprime crisis was "reasonably well contained."

And in July Citigroup's CEO Chuck Prince said: "When the music stops in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."

All those executives are now out of work and all their banks are now wallflowers.

By August, risk aversion spread through the marketplace, and has since paralyzed credit markets and caused a tightening of lending standards for consumers and businesses.

That's why we might want to listen cautiously to what the bank CEOs are saying now. Richard Fuld, CEO of Lehman Brothers, commented at the company's annual meeting that the worst is "behind us." Morgan Stanley CEO John Mack told investors that the collapse of the subprime market in the U.S. has reached its eighth inning or maybe the "top of the ninth."

Weighing against that are findings of a new CEO survey from the Financial Services Forum, which represents 20 of the largest U.S. financial companies. The survey showed that executives by a wide margin believed that the current credit turmoil has far to go; one in three of those CEOs polled put the likelihood of a recession at 100 percent.

Among the trade group's members is current Merrill Lynch CEO John Thain, who reported on Thursday that the investment bank had a $2.14 billion first-quarter loss and write-downs of $6.5 billion on its debt including mortgage-related securities and leveraged loans.

"I hope those who say we are at the end are correct. I am somewhat more skeptical," Thain told the Financial Times after the earnings were released.

Last summer, Bank of America's Ken Lewis seemed confident that the end was nearing for the housing slump. On Monday, the Charlotte, N.C.-based bank said its profits tumbled 77 percent in the first quarter due to trading losses and a $3.3 billion increase in reserves for problem loans.

"I think first it would be too early to strike up the band and sing happy days are here again," Lewis said Monday on a conference call with analysts during which he said the situation in the capital markets was particularly tough in March.

Forget about ninth, or even eighth inning. Maybe we haven't even gotten to the seventh inning stretch yet.

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