Credit Crunch: Lessons & the future

In around October last year, somebody asked me when I thought the writedowns would peak and how I saw the industry moving forward. My answer was that writedowns would be peaking in Q1 2008 with mortgage origination kick-starting in Q2 2008. How wrong/right was I?

Writedowns seem to have peaked in Q1 with UBS even setting up a SPV for the purpose. Hwoever other ibanks like Lehman have subsequently written-off their highest amounts after this ($2.8bn for Lehman). However in general, all the ibanks and other banks with significant ibank business have now writtendown most of their losses. Citigroup and Merrill Lynch will most likely writedown $10bn more, but that should be it.

As for the origination business, here I was totally wrong and the business of securitising mortgages adding some gilts and assigning the package with a AAA credit rating is either finished or won't start for a few years.

The implications have been/will be acute:

1. restructured industry: at a macro-level Bear Stearns is gone leaving 4 big ibanks. Of the 4, two will probably have to find financial godfathers who can provide cheap funding. At a micro-level, the experience of having a colleague who sat next to me just come upto me and say "all the best, I'm off" (I actually thought he was taking the afternoon off until I saw him do the same to several others); of having a meeting with somebody, getting to my desk, give them a call and just find out they've left (i.e. just been made redundant) not once but twice within two days, will stay with me for a while.
2. deleveraging: will be the main focus for at least some part of this year not just for ibanks, but for normal banks. Many are reducing their balance sheets, raising capital via rights and private placements and concentrating on advisory rather than underwriting business
3. straightjacket mortgage lending: many banks can no longer afford to go to the wholesale market because funding is expensive (100 basis points higher than base rate in the UK). They are thus lending based on deposits, cue fewer choices of mortgages (2,400 mortgage products compared to 8,900 sametime last year). Products such as 2yr fixed-rate mortgages (a staple of the UK market) may well disappear for the foreseeable future. The mortgage industry is already less competitive
4. Macro-economy: demand has been sucked out of the housing market, meaning falling prices. Falling prices mean fewer households taking equity-based lending, reduced spending. Combine that with rising inflation due to oil and commodity price inflation and recession will just about be avoided in the UK (but not in the US). Because of deleveraging and inflation, world economy will generally see a slow 2008 & 2009.

Sobering...