By Ambrose Evans-Pritchard
08/07/2008
SourceBridgewater Associates has issued an apocalyptic warning to clients that bank losses from the worldwide credit crisis may reach $1,600bn (£800bn), four times official estimates and enough to pose a grave risk to the financial system.
The giant US hedge fund said that it doubted whether lenders would be able to shoulder the full losses, disguised until now by "mark-to-model" methods of valuing structured credit.
"We are facing an avalanche of bad assets. We have big doubts as to whether financial institutions will be able to obtain enough new capital to cover their losses. The credit crisis is going to get worse," said the group in a confidential report, leaked to the Swiss newspaper SonntagsZeitung.
Bank losses on this scale would have far-reaching effects. Lenders would have to curtail loans by roughly 10-to-one to preserve their capital ratios. This would imply a further contraction of credit by up to $12,000bn worldwide unless banks could raise fresh capital.
It would be almost impossible to attract or even find such sums from investors. While sovereign wealth funds command roughly $3,000bn in funds, this money is mostly committed already. The funds have grown extremely wary of Western banks with sub-prime exposure after burning their fingers so many times already.
Bridgewater said true losses would mushroom if the banks were compelled to use "mark-to-market", which foretells a much crueller haircut for investors in the outstanding pool of structured debt from mortgages, credit cards, car loans and such like, together worth $26.6bn.
The International Monetary Fund has estimated bank losses of roughly $400bn. A chunk has already been covered by fresh infusions of capital, allowing the lenders to continue lubricating the global financial system without having to squeeze credit too hard.
The great unknown is whether this is the end of the debacle. A number of hedge funds believe the alleged losses - typically measured by the ABX index - may overstate the likely level of defaults. They are buying the spurned securities for as little as eight cents on the dollar.
If Bridgewater is anywhere near correct, governments alone have the wherewithal to rescue the system. This would mean the de facto nationalisation of the banking systems in the US, Britain and Europe.