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Friday, August 29, 2008

Heavier Ax for Wall Street?

Poor Credit Conditions, Steady Drip of Firings Suggest More Pain in Fall

The securities industry pays well, but employment is highly volatile. And autumn is typically the season of greatest sadness. Horrid credit conditions and this summer's steady drip of firings suggest the ax will fall with full force when Wall Street hobbles back to business after Labor Day.

Despite news ranging from layoffs, to hiring freezes, to bans on color copying, the official jobs figures don't yet show major stress. Employment in the industry actually rose 0.4% in the second quarter from the first, according to Department of Labor statistics. But this is cold comfort, as there is a lag between the announcements of layoffs and their appearance in government figures.

Moreover, the bloodletting appears to have grown heavier since the end of June. This is worrying. Employers typically don't cut many jobs in the summer. A study by human-resources firm Challenger, Gray & Christmas suggests firings over the past 15 years, on average, were 18% lower in the summer than in the spring.

Employers typically then pick up the pace in the fall as budgets for the following year come in tighter -- sackings ramp up 30% from the summer. It is only somewhat coincidental that fewer mouths mean bigger bonuses for those who remain.

How bad could it get? Many recruiters claim this may be the direst financial crisis in decades. And the longer the crunch lasts, the better the chances become that this crack could cause Wall Street even more pain than the big downturn of the early 1970s.

About 17% of securities industry workers lost their jobs from 1972 through 1974. In New York City, nearly one in four did. Smart bankers should start squirreling away those nuts before the cold snap hits.

Refinancing the Financiers

Debt refinancing is the next big challenge for the world's banks. After being mauled by subprime-mortgage-related losses and tortuous capital raisings, financial institutions must renew an increasing proportion of their own funding, and at a much greater cost.

This refinancing challenge is another legacy of the credit boom. When times were easy, in 2006, banks shortened the maturity and increased the volume of their floating-rate notes, which pay a fixed premium to the London interbank offer rate, or Libor, a benchmark meant to reflect the rates at which banks lend to one another.

That exuberance leaves $871 billion of long-term debt to refinance by the end of 2009, according to J.P. Morgan Chase.

If the rollovers came in May, it wouldn't have been so bad. Then the spread on credit default swaps for financial institutions on the Itraxx index had fallen to 0.54 percentage point from 1.3 points in March.

With economies stumbling and house prices still falling, the spread has climbed back above 0.9 point.

The refinancing schedule seems to be influencing the CDS spreads of individual banks. Take UniCredit. Over the past year, the Italian bank's spread has widened 113%, not too bad a performance in a dismal credit market.

But almost half of that widening has come in the past month, perhaps in recognition that it has to roll over $6 billion of floating-rate notes by Sept. 12.

In contrast, Barclays has no floating-rate notes to roll over before December. Its CDS spread has widened a modest 14% in the past month. Refinancing uncertainty may have contributed to wider spreads at the brokers -- up 60% in the past three months at both Merrill Lynch and Goldman Sachs Group (both suspect companies).

In a deleveraging financial world, rolling over debt no longer is necessarily a routine operation, even for solid institutions. But once the banks and brokers find the new money, they have to deal with the consequences.

The highly leveraged balance sheets of financial institutions multiply the effect of higher funding costs. All things being equal an added 0.3 point on interest rate paid translates into something like two points in lower return on equity.

Wall Street Journal; August 28, 2008