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Big banks counting mortgage crash costs

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  • Big banks counting mortgage crash costs

    Big banks counting mortgage crash costs
    5:00AM Friday September 14, 2007
    By James Doran

    US banks have been hit by the biggest financial credit crisis since the crash of 1998. Photo / Reuters

    The world's top investment banks face a US$25 billion ($35.22 billion) profits plunge as the global credit crisis continues to take its toll on the once all-powerful finance houses.

    Investment banks are braced to reveal in the next few weeks how hard they have been hit by the biggest financial crisis since the market crash of 1998.

    Most Wall Street analysts agree that investment banking businesses at the biggest broker dealers expect profits to be as much as 70 per cent lower in the second half of the year.

    Such a big drop in profits from the most lucrative side of their businesses would translate into an overall profits drop of 40 per cent for the investment banking sector by the end of the year.

    Much of the impact of the financial crisis will be felt before the end of this month, however, as the banks reveal their profits for the all-important third quarter.

    "The third quarter is likely to be the tougher of the two in the second half," said Nick Hill, investment banking analyst with Standard & Poor's.

    Research by the Observer using Standard & Poor's data shows that the 11 biggest investment banks in the world made a combined pre-tax profit of US$61.7 billion ($87 billion) in the first six months of the year.

    In a recent research paper published by Standard & Poor's, Hill estimated that in the second half of the year profits would fall by US$24.7 billion ($34.8 billion) across the board.

    Taken alone, the top five Wall Street banks - Morgan Stanley, Goldman Sachs, Merrill Lynch, Bear Stearns and Lehman Brothers - could see as much as US$7 billion ($9.8 billion) wiped off their profits.

    The market crisis began in the so-called sub-prime mortgage market in the US. Lenders allowed would-be homeowners with poor financial resources and weak credit histories to borrow large amounts of money to buy homes.

    The mortgages were bundled in packages of securities and derivatives worth billions of dollars, to be traded between banks and hedge funds.

    As large numbers of mortgage holders began to default it became clear that the debt-backed tradeable securities and derivatives were essentially devoid of value and trading in such vehicles ceased, spooking investors, who pulled billions of dollars of liquidity out.

    Now, the banks left holding those securities and derivatives have to quantify how much they have lost. Whole funds made up of worthless debt have collapsed. What is more, the liquidity drought has caused problems for banks that promised to underwrite large issuances of debt for companies and private equity houses striking mergers and acquisitions. As the debt cannot be sold, the banks are on the hook for yet more billions of dollars that will be felt in the bottom line.

    In addition, the stock market has not been performing well, reducing revenues and profits further still among the investment banks, whose shares have plunged substantially in value.

    Profit crunch

    * Eleven biggest investment banks made US$61.7 billion ($86.9 billion) in profits in first six months of the year.

    * In the second half, profits across the sector are expected to drop US$24.7 billion ($34.8 billion).

    * The top five Wall Street banks could see profits fall US$7 billion ($9.85 billion).

    - Observer

    "There's one way to find out if a man is honest-ask him. If he says 'yes,' you know he is a crook." Groucho Marx