Tags: Ben Bernanke, Finance, Goldman Sachs

Goldman Sachs Sees Lending Taking a Trillion Dollar Hit

By , Money Morning •

By Jason Simpkins
Associate Editor

Subprime defaults and the ongoing mortgage crisis could have a "dramatic" impact on the overall economy, as banks and other financial institutions cut back their lending by as much as $2 trillion, according to an economist with Goldman Sachs Group Inc. (GS).

In a Nov. 15 report, Goldman Chief Economist Jan Hatzius said losses related to U.S. home foreclosures could reach $400 billion, as leveraged institutions will struggle to preserve their capital ratios. In that sense, the loss would not be an outright decline, but relative to the normal growth of lending.

"If leveraged investors see $200 billion of the $400 billion aggregate credit loss, they might need to scale back their lending by $2 trillion," Hatzius wrote. 

If this occurred within a one-year period, this could cause such a financial shock that it would result in a "substantial recession," Hatzius said. But if those losses were stretched out over a longer period, however, it would translate in a protracted period of sluggish growth.

Goldman’s forecast already assumes lending will fall by $1 trillion - half the potential decline - over the next two years.

"It’s basically another downside risk to the macro-economy at a time when the macro-economy already isn’t doing that well," Hatzius said in an interview with CNBC TV. 

Hatzius also said in the interview that this is yet "another reason for why the Fed will need to ease monetary policy," presumably when the policymaking Federal Open Market Committee (FOMC) meets again in December. The chance of the FOMC slashing rates by another quarter point at that Dec. 11 meeting stands at 86% according to futures prices on the Chicago Board of Trade, Bloomberg News reported.

But during a speech in New York Friday, Federal Reserve Governor Randall Kroszner talked down the chances of a rate cut.

"The downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation," Kroszner said.

Kroszner said policymakers probably wouldn’t need to reduce interest rates further to help the economy weather a "rough patch" in the coming year.

Goldman Sachs was the only major financial institution to post a third-quarter profit, having limited its exposure to the subprime market and mortgage-backed assets before that market collapsed.

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