Goldman (GS) Puts Recession Odds Very High

Losses related to record U.S. home foreclosures using a “back-of-the-envelope” calculation may be as high as $400 billion for financial companies, Jan Hatzius, chief economist at Goldman (GS) in New York wrote in a report dated yesterday, Bloomberg reports. This could cause overall lending to drop by as much as $1 trillion over the next two years.

The ramifications are worse than the reports states, at least on its face. Mortgage banks including Countrywide (CFC) could be further damaged by more foreclosures and less lending. This problem could spread to money center banks with large mortgage operations. HSBC (HBC) has already taken write-downs in this area of its operations. A sharp increase in bad loans would do more harm here, and capital from new loans would not come through the door to help liquidity.

The other sector that could be dragged down with a sharp spike in foreclosures is the bond operations at the large investment banks. Bear Stearns (BSC) and Citigroup (C) hardly need more financial strain on the value of their pools of financial instruments tied to mortgages. At some point the falling prices of these assets will force more losses at these banks.

The message Goldman is sending is that the financial industry in the US may not be out of the woods. It actually may be entering a worse period than it has experienced over the last five months.

Douglas A. McIntyre