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Banking woes seem to ease. Is it a sign?

Evidence of stability includes easing US bond prices and bank moves to raise capital.

By Staff writer of The Christian Science Monitor / April 23, 2008

The turbulent times for banks aren't over, but suddenly it seems that bankers have a bit more opportunity to breathe.

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It's been a month since the overnight collapse of Bear Stearns, and it appears that policy moves by the Federal Reserve have helped to restore a sense of order to financial markets. Wall Street hasn't been rocked by further corporate earthquakes, and executives at some investment firms are saying the worst of the crisis is over.

Saying so doesn't necessarily make it so. The economy still faces broader concerns over housing woes and oil prices that could delay a recovery. But some signs of stability are emerging:

•Mainstream banks announced big quarterly losses this week but also moved to raise fresh capital for the future.

•Investment banks, which are also exposed to souring home loans, have reduced their borrowing from the Federal Reserve for two weeks in a row – a trend that may reflect reduced stress.

•Investors have backed away from a panicked "flight to safety," with Treasury bond prices falling as fewer people rush to buy them.

"After Bear Stearns's crisis and the Fed's strong actions ... things seem to have stabilized somewhat," says Rajeev Dhawan, director of the economic forecasting center at Georgia State University in Atlanta. "If [banks are] able to raise capital and shore up their balance sheets, then that's a positive sign."

After about eight months where fear and uncertainty have dominated Wall Street, the recent shift in mood is a welcome one. It signals that, despite ongoing problems, bankers hope to manage their way through the mess.

The mess is a large one, however.

The International Monetary Fund, in a report on global financial stability this month, estimated that the crisis centered on US home loans could ultimately shave nearly $1 trillion off the balance sheets of banks, insurance firms, investment companies, and government agencies.

The IMF's estimate of $945 billion in losses includes effects of a broader economic slowdown, as high oil prices and falling home values shake consumer confidence. Mortgages are the biggest worry, but the report also predicts losses for everything from credit cards to commercial real estate and corporate loans.

If that scenario proves accurate, with roughly $1 in every $23 in loans going bad, some banks will fail, analysts say.

The uncertainty about which banks are most at risk, together with the pressure to conserve cash to cover their losses, continues to make banks reluctant to lend to each other as they normally do to cover short-term needs.

"The problem right now is the banks are not lending to each other," Mr. Dhawan says.

The financial crisis will hinge on how the economy performs in the months ahead.

Consumer spending is already strained by high energy costs and a reduced pool of housing wealth to borrow against. The more consumers struggle, the more loans could go bad.

But several forces could help avert a deep consumer-driven slump. Dhawan predicts that oil prices will decline later this year, in tandem with the cooling economy. He adds that corporations have lean staffing already, so that a recession may not mean such large job losses as it has in the past. The dollar's weak value, meanwhile, is helping to spur demand for US-made exports.

Where the losses land in financial crisis

The credit turmoil spawned by a US housing slump and related economic slowdown could cause nearly $1 trillion losses out of $23 trillion in outstanding loans and loan-related securities. About half the problem rests with banks, half with other institutions.

Potential losses, in billions:

Banks $440-510

Insurers $105-130

Hedge funds/other $110-200

Pension funds $90-160

Government* $70-140

Total $815-1,140

*Including independent enterprises with government sponsorship, such as Fannie Mae.

Source: International Monetary Fund staff