Goldman Sachs, the feted investment bank and the only major Wall Street firm to have avoided giant losses from the credit crisis, is betting that the chaos in the American mortgage market will continue to get worse.
As some of the finance industry's most powerful executives gathered for an industry conference in Manhattan, Lloyd Blankfein, the chief executive of Goldman Sachs, said his firm was still holding to its lucrative bets that the value of mortgage-backed securities will fall.
And at the same conference, an executive from its smaller rival Bank of America announced that it would probably be writing down the value of its mortgage portfolio by a further $3bn (£1.45bn) at the end of the year.
An array of complex debt products, such as mortgage-backed securities and collateralised debt obligations (CDOs), collapsed in value over the summer as Americans began defaulting on the underlying mortgages in record numbers. Many of the most obscure products are now virtually untradeable, and Wall Street has struggled to work out the scale of the losses on which they are sitting. So far, firms have written off a total of about $45bn, but Mr Blankfein and other presenters at the Merrill Lynch banking and financial services investor conference said that figure would go higher still.
But there would be no write-downs at Goldman Sachs, Mr Blankfein said. The company continued to be "net short" of mortgage-related markets, he said, indicating that the company's bets against the value of such securities outweigh its actual holdings. His comments confounded sceptics who thought Goldman might have to admit it too had suffered losses, and the reassurance helped fuel the rally in financial sector stocks and the broader market. The Dow Jones Industrial Average closed up 320 points, around 2.5 per cent.
Over the next two years, an estimated 3 million American homeowners will face a sharp increase in their mortgage bills, as low, introductory "teaser" rates expire. With house prices falling, and with mortgage companies limiting the number of loans on offer after years of profligate lending, industry players fear further rises in defaults and repossessions. That will erode the value of the Wall Street debt instruments among which those mortgages have been sliced and diced.
Larry Fink, whose fund management firm BlackRock helped create the market for mortgage-backed securities, echoed predictions that the crisis could get "a lot worse". He told attendees: "Many institutions don't understand what the credit crunch is going to do to earnings and their balance sheet." Mr Fink is considered a leading candidate for chief executive of Morgan Stanley, the investment giant which owns a controlling stake in BlackRock. Stan O'Neal was ousted as chief executive of Merrill Lynch last month after being forced to admit that mortgage-related losses had ballooned to $7.9bn.
Bank of America suffered trading losses of $1.5bn over the summer and its chief financial officer Joe Price said yesterday that an additional write-down in the order of $3bn would be necessary.
Jamie Dimon, the chief executive of JPMorgan Chase, told the conference that his bank was "fine" but that structured investment vehicles – the off-balance-sheet vehicles used by some Wall Street banks to trade mortgage-backed securities – "would go the way of the dinosaur". Many SIVs are already having to be rescued by the banks that created them, and Bank of America's Mr Price said it would spend $600m propping up its funds.
Ratings agencies say mortgage chaos took them by surprise
The main credit rating agencies have admitted to MPs that they failed to spot the looming credit crunch and that investors had taken their positive ratings as a "green light" to buy opaque securities.
"In hindsight we would have rated them differently," said Ian Bell, head of European structured finance at Standard & Poor's, referring to credit products whose values crashed after 9 August.
Paul Taylor, Fitch's European head, told the House of Commons Treasury Committee: "Even though we drew attention to deteriorating credit risk ... this wasn't being reflected in investors' behaviour."
Mr Bell acknowledged that some investors had taken a top rating from the agencies as a "green light" to invest inobscure products.
The agencies said they had earned fees from Northern Rock for rating its securities, but that these played no part in their failure to downgrade the mortgage bank between itsinterim results in July and the Bank of England's emergency funding on 14 September.
"Why was it none of you flagged up after July the danger facing Northern Rock?" asked Michael Fallon, the committee's senior Conservative member. Mr Bell said: "August took everyone by surprise. We did not see a way in which the sub-prime crisis would ripple throughout the markets of the world to affect a bank like Northern Rock."
Sean FarrellReuse content