See the complete list of trends that we analyze.

1) Investment & Securities Industry Overview

The U.S. Bureau of Labor Statistics estimated total employment in the investment and securities sector at 847,900 in 2007. However, as 2008 drew to a close, tens of thousands of people had been laid off. According to the U.S. Bureau of Labor Statistics, 142,000 jobs were lost in the financial services sector in the first 11 months of 2008. Job cuts at banks and investment firms were immense, including 35,000 planned cuts at Bank of America after the acquisition of Merrill Lynch, and more than 50,000 at Citigroup. Of course, all of the jobs at the defunct Lehman Brothers have disappeared. Layoffs are widespread and painful throughout the financial industry on a global basis. The financial centers of New York City and London have been particularly devastated.

Mutual fund assets in the U.S. totaled about $9.5 trillion as of November 2008, down about $2 trillion from one year earlier. About 50 million Americans participated in 401(k) investment plans at their places of work in 2008, while tens of millions owned stocks, bonds and annuities in their individual accounts.

Worldwide, according to the Investment Company Institute (www.ici.org), mutual fund assets were $24.6 trillion at the end of the second quarter of 2008 (down from a peak of $26.15 trillion at in the fourth quarter of 2007).

From 2002 through the end of 2007, total household net worth in America climbed from $39.2 trillion to $58.7 trillion. Much of that added value was wiped out in 2008.

In late 2007, former U.S. Federal Reserve chief Alan Greenspan estimated the total value of equities traded on major exchanges around the world at $50 trillion, about double what it was five years earlier in 2002. At the same time, he estimated the total value of global long-term securities of all types at nearly $100 trillion, including stocks, bonds and other financial instruments. These totals dropped very severely on a worldwide basis by the end of 2008.

The term Sovereign Wealth Fund (SWF) is used to describe a national government’s pool of assets available for investment. Nations that are major exporters, such as the oil and gas exporting nations of Saudi Arabia, Kuwait and Russia, have earned massive amounts of excess capital, and their SWFs have become a major influence in the investment world of today. SWFs, under governmental control, may be subject to cronyism and mismanagement. By the beginning of 2008, the world’s SWFs totaled about $3 trillion by some estimates.

The investment sector as a whole faces significant challenges for 2009. By the end of 2008, the industry, on a global basis, had been through losses, layoffs, scandals, bankruptcies, bailouts and/or disappointments on a scale not seen in decades. Asset values have plummeted. Virtually all stock market indexes have been down by as much as 40% to 50%, depending on geographic location. Bonds in general have seen a big decline in value in recent months, but U.S. treasuries have soared in value as investors sought a safe haven for their money. Private equity deals as well as corporate mergers and acquisitions activity have declined dramatically—often because financing is not available. IPOs have been nearly nonexistent. Venture capital firms have been cautioning their portfolio companies to conserve cash. University endowments, charitable foundation assets and pension funds have lost billions of dollars. The world’s leading investment and commercial banks have been through immense changes—many seeking emergency injections of capital or emergency mergers. Two outstanding survivors, Goldman Sachs and Merrill Lynch, both gained U.S. government approval to convert their status to that of bank holding company in order to have access to capital from the Federal Reserve Bank.

Adding insult to injury was the stunning revelation in late 2008 that a highly respected investment manager in New York was running an alleged scam that may involve as much as $50 billion in losses to investors. Unfortunately, these investors included many charitable foundations, banks, colleges and pension plans, in addition to wealthy individuals, hedge funds and other sophisticated investors. How could such sophisticated investors be so culpable? How could regulators completely miss the fact that this was probably going on for years? Last, but not least, how could someone who was widely known and respected turn out to be evil enough to perpetrate such a fraud? The whole world wonders, and the reputation of the entire financial industry has been hurt as a result. The timing couldn’t have been worse, as investor confidence was already at an extremely low point. At nearly the same time, a New York lawyer was arrested in December 2008 for allegedly using falsified documents and other tools to pose as the representative of large, legitimate borrowers, resulting in a scam topping $300 million.

The financial services industry (banking, lending, credit cards, investments and insurance) was suffering miserably on a global basis as 2008 wound to a close, in the midst of what will be remembered in business history books as the “Great Financial Crisis of 2008.” Hopefully, central banks of governments worldwide have acted aggressively enough and powerfully enough to keep the financial crisis of 2008 from evolving into a “great depression of 2009.” However, the turnaround of the world’s economy and a rebound of the banking and investment system will take a long and trying time.

How did this disaster occur? Multiple factors were involved, many of which began as long ago as 2001, including:
• An era of loose lending rules for business loans.
• Incredibly easy credit for consumer loans, including mortgages, automobile loans and credit cards.
• Exceptionally low interest rates.
• A multi-year, worldwide economic boom that encouraged risk-taking by borrowers and lenders alike.
• A multi-year, worldwide jump in market prices for stocks, houses, commercial real estate, companies and commodities that further encouraged risk-taking and easy lending.
• Booming global markets for manufactured goods and for commodities such as oil created immense cash reserves in emerging nations, and much of those reserves were eagerly invested in debt instruments of all types, further fueling lending.
• Investors in debt-backed securities were lured into a false sense of security by overly optimistic ratings placed on those securities. Many very highly rated mortgage packages turned out to be of little value. Meanwhile, investors often thought their risks were well-covered by “credit default swaps (CDS),” a type of insurance that will pay off if a debtor defaults. However, the CDS are only as good as the finances of the company backing them.
• Investment banks, such as Lehman Brothers, were overextended, operating with very high leverage. Typically, they were holding assets of about 30 times their total level of capital. That means that they were borrowing heavily, at a rate of about $97 for every $3 of capital, and that a downward turn in asset values could quickly have devastating effects on their balance sheets.

Finally, in mid-2007, the bubble began to pop when a financial firm in Europe awoke to find that there was no longer an eager market for the mortgage-backed securities that it wanted to unload. The world of finance entered a downward spiral.

It would be easy, but incomplete, to point the blame at the United States. America is an easy target for blame—as the world’s largest economy by far, America’s economic bust has affected lenders, businesses and investors on a worldwide basis. Of course, those lenders, businesses and investors also benefited broadly, and gleefully, from America’s tremendous boom from 2003 through most of 2007.

America’s soaring housing market and easy credit led to the creation of poorly-conceived mortgages and mortgage securities. Investors who bought them have suffered. However, eager lenders, rocketing house prices, easy mortgages, aggressive construction of houses and high consumer debt were found not only in America, but were also matched or even exceeded in nations like the U.K. and Spain, and in major cities in nations such as Australia and Canada. Housing markets, stock markets and risk-taking rose to absurd levels in cities in Russia, China and India as well. The U.S. did have a unique impetus to its mortgage market: In recent years, Congress had unwisely pushed the banking and mortgage industry, including government-sponsored mortgage banks Fannie Mae and Freddie Mac, to make home ownership easier to attain for people of modest income.

Investments, banking and financial services of all types have become globalized industries in recent decades, in the same way that the automobile, pharmaceutical, technology, energy and consumer goods industries have globalized. The globalization was fueled by four factors: 1) the availability of global electronic networks for distribution of funds and real-time management information; 2) the easing of local regulations on ownership of investment and banking firms by foreign entities; 3) the opportunity to serve the needs of multinational corporations; and 4) the increasing attractiveness, from a banker’s point of view, of business assets and rising household wealth in emerging economies. New business opportunities were sought out globally by major banks and investment firms, especially in such booming markets as China and India.

In our research published during 2005, 2006 and 2007, Plunkett Research consistently warned of the high debt levels carried by American consumers and of the pending difficulties in the mortgage market due to lax lending practices and adjustable interest rate loans. By late 2007 a high level of defaults and foreclosures had clearly come home to roost, creating significant turmoil in banking and credit markets both in the U.S. and abroad.

As of August 2008, American households owed more than $2.57 trillion in consumer debt, such as auto loans and credit card debt, up from $1.99 trillion at the end of 2002. The 2008 total is more than triple the amount owed in 1990: $808 billion.

Growth in residential mortgages has been even faster. At the end of 2002, total mortgages outstanding in the U.S. for single-family homes and properties of up to four residential units totaled $6.4 trillion. By mid 2007, that amount had ballooned to $10.7 trillion, according to the Federal Reserve. This was an unprecedented growth rate totaling 67.1% over five years. By June 2008, the amount had grown to $11.25 trillion. This is more than four times the amount owed in 1990: $2.61 trillion.

Up until early 2007, mortgage lenders had been pushing a long list of innovative products designed to make it easier to borrow while lowering monthly payment and credit rating requirements. Some of these mortgage variations were bound to lure consumers into self-destructive borrowing and buying as they paid too much for properties while diving deeply into debt. These products ranged from zero-down payment mortgages to 40-year, fixed-rate loans to “option” loans that allow the borrower to defer a large part of each month’s payment. Many home owners now find themselves vastly overleveraged as a result of such mortgages. Banks, investment houses and investors of all types have written off hundreds of billions of dollars in mortgages during 2007 and 2008 as a result. Housing markets are in a deep slump and will remain so for some time to come.

What’s next in the world of banking, credit and investments? Here are a few emerging trends to watch for: 1) Greatly increased regulatory oversight will restrict investment companies and lenders of all types. 2) An era of much lower risk-taking by traditional lenders has begun that will last for years. 3) The creation of higher-risk loans and investments will be taken over to a major extent by hedge funds and private equity funds, accelerating a trend that has already been in place for some time, and replacing some of the former roles of commercial banks and investment banks. 4) Intense debate will ensue about the possible creation of a global authority that could oversee banking, lending and investment sectors from a high level and perhaps act quickly to commit the central banks of the richest nations as a cohesive force in the event of emergencies. 5) Alternative lending sources will be used to a growing degree by small businesses and some consumers unable to get loans elsewhere. For example, peer-to-peer lending companies are growing through enabling lending by and between members of lending clubs, or between friends and family. Virgin Money USA, for example, makes it easy for reliable small business owners to set up loans from friends. Prosper.com enables borrowers to apply for three-year, fixed-rate personal loans online by connecting borrowers with individual lenders. On the other end of the spectrum, small businesses that are unable to obtain or renew bank loans will turn to high-cost “factoring,” a method of borrowing against their receivables. 6) A lengthy and expensive process of write-downs by lenders will continue. Chris Flanagan, an analyst at JP Morgan Securities, estimated in late 2008 that the potential total of bad debts that need to be written off by lenders and investors worldwide stood at $1.7 trillion. The International Monetary Fund (IMF) estimated the potential loss at $1.4 trillion in October 2008. The final toll could be even worse than these numbers, given the fact that significant losses from credit card debts, automobile loans, junk-rated corporate bonds and shaky municipal bonds will occur in 2009 and 2010. 7) Investment banks will operate on lower profits, smaller employee counts and smaller balance sheets. Morgan Stanley and Goldman Sachs will take advantage of their new status as bank holding companies. They will seek alternative means to gather assets, such as an effort to offer consumers and businesses the opportunity to open bank accounts in addition to brokerage accounts. 8) Regulatory oversight will increase, and regulatory agencies such as America’s SEC, will get an overhaul. Investment companies, banks and insurance companies will brace for much higher levels of scrutiny.

Source: Plunkett Research, Ltd.