Yves Smith at Naked Capitalism submits:
Bloomberg reports that a Standard & Poors report points to a steeper fall in Wall Street earnings for the second half of 2007 than in the Russia default/LTCM crisis period, the second half of 1998. Weirdly, S&P goes to some length to say this isn’t a forecast but a “stress test.” Is that because this scenario is too politically charged, or because the possible outcomes for the industry are too murky for S&P to stick its neck out?
Intuitively, this projection makes sense. The 1998 debacle devastated emerging markets units and roiled the fixed income and swaps markets. This time, the fallout extends into investment banking, since M&A, the biggest profit engine, became dependent on large LBO deals. Currencies, derivatives, and fixed income, much more important profit sources than a decade ago, have also suffered badly.
Standard & Poor’s said business conditions for securities firms are worse than in the second half of 1998 and revenue from investment banking and trading could fall 47 percent in the final six months of this year….
“This is more severe than in 1998,” when investment- banking and trading revenue fell 31 percent in the second half following Russia’s debt default, S&P analyst Nick Hill said in the statement…As in 1998, firms are likely to cut bonuses to stay profitable, said Hill, who is based in London….
S&P looked at seven U.S. and four European banks. Banks most at risk include Bear Stearns Cos., Deutsche Bank AG and others more dependent on fixed income, S&P said. The “least affected should be Citigroup Inc. and Morgan Stanley,” which are more diversified.
Markets recovered quickly after the 1998 drop and favorable economic fundamentals now could cushion the impact of declines in investment banking and trading, the report said. This time, “the source of the problem has shifted from emerging markets to the world’s most developed economy.”