S&P has issued a report today noting that the subprime writedowns could reach $285 Billion, which is higher than the $265 Billion it noted before. But there is a silver lining to the report and that is that S&P noted that the writedowns are past the half-way mark. The stock market is still in negative territory, but not down as much as before.
It also notes that the end for huge writedowns is in sight at the big banks. This pertains to the asset-backed securities, noted primarily as collateralized debt obligations of ABS but also subprime residential mortgage-backed securities.
In a companion report from S&P, it notes that the bulk of the write-downs of subprime securities may be behind the banks and brokers that have already announced their results for full-year 2007. While there may be more mark-to-market actions, it is their opinion that the magnitude of some write-downs is actually greater than any reasonable estimate of ultimate losses. In short, they think the amounts being given writedowns are more than the real losses will ever be. This also notes that credit spreads and the repricing of credit risk will hit financial institutions the hardest.
We ultimately think the writedowns may be more than this. We recently noted a $325 Billion figure. A report out of Morgan Stanley is based a subprime-related housing market drop of some 30%. Frankly, the ultimate number isn’t as material as the as the number of institutions that can be taken down by this. The deleveraging is happening across the board. That was before the extra $100 Billion gift from the Fed, making a total of $200 Billion.
As writedowns continue, the real issue is going to be how the market reacts to the next wave of major writedowns. At some point it will ultimately boil down to which firms will obviously survive and which ones are at risk. The second half of this writedown cycle will be the hardest for investors to grasp. It still seems that the beatings will continue until morale improves.
If the FHA will step in or if the government will ultimately absorb some of this, then this report will prove true and we might not see the worst case scenario come to pass. But that makes for a total bailout package and rewarding bad behavior, and it also puts another slug in the free markets into a "free markets, with a put option" into the mix.
Jon C. Ogg
March 13, 2008