Financial Write-Downs May Just Be Starting (C)(BSC)(JPM)

Goldman Sachs says that write-downs for subprime mortgage paper, LBOs, credit cards,and other bad paper could hit banks and brokerages for $460 billion. That is almost three times the write-offs taken by financial firms so far.

According to Bloomberg, Goldman "estimated that residential mortgage losses will account for half the total, and commercial mortgages as much as 20 percent.."

If the number is anywhere close to being true, Bernanke and Paulson, who now basically run the US, have a problem which even they cannot solve. The banks have tapped the Fed for about $200 billion. Where the next $250 billion would come from is anyone’s guess.

It will not come from sovereign funds They have already lost money on almost every bank and brokerage where they have invested. Comments from the big Middle East funds indicate that they think that companies like Citigroup (C) have a long way to go in cleaning up their balance sheets.

The Fed has one chance to salvage its own savings account. It can do for the rest of the financial system what it did with Bear Stearns (BSC). It went to JP Morgan (JPM) and had the bank buy the brokerage but put up $30 billion as a back-stop. If JPM does well, the Fed will not have put all of that money into a sink hole. It will go back into the Fed’s account.

The Fed could do the same thing for a number of the largest brokerages and banks. It could go to sovereign funds and say "put up $100 billion and buy a nice piece of these companies", If things fall apart, we will guarantee some of your investment. The sovereigns would have risk, but it would not be unlimited.

Or, the Fed can put up money that it does not have and knee cap the taxpayer. If the economy gets much worse that taxpayer won’t have the money to pay his taxes.

Douglas A. McIntyre