While analysts debate the extent that mortgage-related losses will impact bank profits, it is useful to remember that the ultimate impact of the credit market turmoil on the general economy is through reduced lending. Bloomberg reports some estimates from Goldman Sachs.
The slump in global credit markets may force banks, brokerages and hedge funds to cut lending by $2 trillion and trigger a "substantial recession" in the U.S., according to Goldman Sachs Group Inc.
Losses related to record home foreclosures using a "back-of-the-envelope" calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief U.S. economist at Goldman in New York wrote in a report dated yesterday. The effects may be amplified tenfold as companies that borrowed to finance their investments scale back lending, the report said.
"The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized," Hatzius wrote. "It is easy to see how such a shock could produce a substantial recession" or "a long period of very sluggish growth," he wrote.
The full effects of the credit crunch have certainly not filtered through to the real economy, but already, some signs of slowing are evident. The Federal Reserve reported yesterday that US industrial production fell 0.5 percent in October. The Economic Cycle Research Institute reported that its Weekly Leading Index fell to 140.0 in the week ended 9 November from 140.3 in the prior week while the growth rate fell to minus 0.9 percent, a 60-week low, from minus 0.7 percent.
US stock investors don't seem overly perturbed by the negative news, though, the stock market finishing up yesterday. In fact, the Dow Jones Industrial Average gained one percent over the week.
Slowing in industrial production hasn't been limited to the US. Even China seems affected, reporting an increase in industrial production by 17.9 percent in October from a year ago compared to 18.9 percent in September. Nevertheless, more tightening is expected from China after fixed-asset investment in urban areas was reported yesterday to have risen by 26.9 percent in the first 10 months of 2007.