The jury is still out on how bad the fallout will be for investment banks that barrelled headlong into the mortgage markets — though some are faring better than others.
Many of Wall Street’s investment banks have suffered from massive write-downs after they kept packaging and trading subprime securities for high fees without taking the necessary measures to protect themselves against the positions they were buying.
For instance, Citigroup has written down about $40 billion in assets, while Merrill Lynch, the nation’s largest brokerage firm, has taken $45 billion worth of write-downs. UBS, which has seen $38 billion in write-downs, has been the European bank slammed the hardest by the subprime mortgage market crisis in the United States.
The funds at Bear Stearns, which contained some of the highest-risk securities available, collapsed in June 2007, causing more than $350 billion in write-downs and culminating in the demise of one of the nation’s largest underwriters of mortgage bonds.
The implosion of the funds caused market panic, which mushroomed into the full-blown credit crisis in August 2007.
At the same time, Goldman Sachs apparently foresaw credit issues: Though it continued to package risky mortgages to sell to investors, the investment bank’s hedges were profitable, though investors took losses on the securities. When credit markets came to a halt in late July 2007, Goldman had sold off the risky mortgages that other investment banks had continued to buy.
“Goldman Sachs fared better than Bear Stearns, because Goldman Sachs is still in business, and Bear Stearns isn’t, right?” said Richard Bove, a managing director with Ladenburg Thalmann & Co., who has gained a reputation since 2005 as one of the few maverick bank analysts to predict the implosion in the housing market and its catastrophic effect on banks.
Bove said the move into real estate by investment banks was predictable.
“Whenever a specific area gets, so to speak, a large amount of funding, what these companies do is move their assets, people, resources into that area in order to take advantage of what’s going on in the sector,” Bove said. “They did that in real estate, and the net effect is they wound up overexposed.”
While Bear Stearns had a narrow focus on the weakest portion of the market, Goldman Sachs had a much broader vision of real estate, he said.
“They focused on a lot of businesses outside of real estate, so instead of concentrating their efforts in this one area, which is what Bear Stearns did, Goldman Sachs, by being diversified, was able to ameliorate the blow of the negative part of the cycle,” Bove said.
The latest investment bank to be making headlines is Lehman Brothers Holdings, the smallest of the major Wall Street firms. The bank was a major player in the residential mortgage market — with about $61 billion in mortgages and asset-backed securities — and with its small balance sheet, fears have swirled that large losses could take it down.
“Lehman is also dealing with the fact that they tended to be overly concentrated in the residential mortgage portion of the business,” Bove said. “In other words, diversification is something which works, and these guys didn’t do it, so they’re now struggling to prove that they have a viable investment strategy.”
In the second quarter, Lehman lost $2.8 billion, mostly caused by write-downs from residential real estate investments, and has stated its intentions of raising $6 billion.
Now some bankers also fear that the commercial property market may be heading south, causing defaults on commercial loans and further write-downs for Wall Street banks, which hold about $100 billion of commercial mortgage-backed securities.
Bove said that, though investment banks wound up overexposed in the residential real estate sector, with bad loans and underperforming assets, those that pull through the crisis will most likely not shy away from real estate in the future.
“Now they will pull back and take a more measured pace at looking at the sector, and then they’ll go at it again the next time it heats up,” he said. “It’s a cyclical business. We’re in a down part of the cycle, but the cycle will change, and it will come back.”