Sunday, November 18, 2007

Buzz: Goldman Sachs Research Report on Mortgage Defaults is Getting a lot of Attention

So no less than 5 major news sources have been referencing a research report put out by Goldman Sachs economist Jan Hatzius. You can see the report for free right here.

It's a short piece that focuses on how the mortgage writedowns and the subprime fallout could become a contagion for other aspects of the general economy. The key, according to Hatzius, is that losses from the mortgage fallout represented leveraged losses, which is different than how most investors perceive their personal stock portfolio losses.

At first glance, it might seem that even $400 billion is too small relative to the size of the financial markets to have a significant effect on the real economy. After all, a $400 billion loss is equivalent to only 2½% of the market capitalization of US equities—equivalent, in other words, to one bad day in the stock market. No serious analyst would argue that a 2½% equity market decline will make an important difference to the economic outlook. So what’s different about the mortgage credit losses?

In a word, leverage. The broader knock-on effect from equity market losses is small because most equities are held by long-only investors, who do not adjust their portfolios in response to a capital loss. According to the Fed’s flow of funds tables, less than 3% of all US equities are held by banks, savings institutions, broker-dealers, or government-sponsored enterprises, all of which are highly leveraged. Although the flow of funds accounts contain no data on hedge funds, we believe that even including hedge funds the total proportion of equities held by leveraged investors would be well below 10%. The remaining 90%+ is mostly held by long-only investors such as households, mutual funds, insurance companies, and private and public pension funds."

More press coverage on this research report:

NYTimes Article

Thomson Financial


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