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Goldman warns of a substantial US recession

Date: Monday, November 19, 2007
Author: Ambrose Evans-Pritchard, Telegraph

Goldman Sachs has sent a shudder through the debt markets, warning that sub-prime mortgage losses could force banks to slash lending by $2,000bn (£980bn) and push the United States into a deep recession.

Jan Hatzius, US chief economist for the Wall Street bank, said potential losses of $400bn from the whole debacle did not begin to capture the scale of any squeeze on bank lending.

"The likely mortgage credit losses pose a significantly bigger macroeconomic risk than generally recognized," he wrote.

"It is easy to see how such a shock could produce a substantial recession or a long period of very sluggish growth," he wrote.

Mr Hatzius said banks would have to shrink their lending by $10 for every $1 in losses in order to maintain capital ratios, vastly magnifying the effects as lending multiples kick into reverse.

"The macroeconomic consequences could be quite dramatic. If leveraged investors see $200bn of the $400bn aggregate credit loss, they might need to scale back their lending by $2 trillion. This is a large shock," he said.

The warning comes as the bank's closely watch Global Leading Indicator - a barometer of the world economy - continued to slow in November.

Goldman Sachs said there was a growing risk that US troubles would spread to Britain and Europe.

This casts doubts on the "decoupling" thesis that the world can pick up the growth baton as America slows, keeping corporate profits buoyant.

"This matters for markets since the assumption of 'decoupling' is now quite well embedded in asset prices. We think that cyclical exposure remains dangerous right here," said the bank, referring to riskier assets and industrial commodities such as copper.

On Thursday the US Federal Reserve pumped $47bn into the banking system, the biggest one-day infusion of liquidity since the 9/11 Twin Towers attack in 2001.

The Fed's survey of US industrial output showed 0.5pc fall in October, with big drops in furniture linked to the property slump.

Wall Street shrugged off the data, betting instead that easing inflation pressures would clear the way for further interest rate cuts.

Dr Suki Mann, a credit analyst at Société Générale, said the corporate bond markets in Europe were still under stress a full four months after the credit crisis began.

'A-rated' Commerzbank faced stiff spreads in a closely-watched bond issue this week.

"These companies are having to pay at least 100 basis points extra over Euribor, and there's no end in sight. A lot of corporations are liquid and have little funding pressure. But if you are a company that needs funding, or if you are a bank that can't borrow, you're worried," he said.

The iTraxx Crossover index measuring default insurance on mid to low corporate bonds rose to 384 yesterday, approaching August crisis levels.

Separately, the US Treasury data showed that Asian countries - joined by France - continued to pull money of the US bond markets in September.

The net sales of US Treasury bonds by country were: China ($3.5bn), France ($3.5bn), Japan ($3.4bn), Korea ($3.2bn). This was offset by inflows from Brazil and petrodollar states investing through London banks.

The total outflow for all forms of investment was $14.7bn, an improvement on the record flight of $150.7bn in August but not enough to cover the monthly US current account deficit of $55bn.

The dollar held up today, boosted by fresh assurances from US Treasury Secretary Hank Paulson that the Washington is not turning a blind eye after the dramatic slide in the Greenback this Autumn.

"Our economy, like any other, goes through ups and downs. But I believe the U.S. economy is going to continue to grow and its fundamental long-term strength is going to be reflected in our currency," he said.