Back in November 2007, when the pundits were expecting a quick recovery from the credit crisis and were promoting financial stocks, I wrote an article that estimated that financial companies would were at risk for over $1.2 trillion in losses.  As I wrote:

We are not even close to seeing the true scope of the CDO and mortgage backed security meltdown.

This will hit banks  and financial institutions in several ways:

1. They will have to continue to write off assets that are tied to or backed by these assets.  Das estimates that every $1 in real assets backs $20 in derivatives and borrowed money.  That means that every time a house forecloses there is a 20X multiplier effect.  Multiply that by the more than 500,000 houses that the US Department of Housing and Urban development expects to face foreclosure next year and then multiply that by the 50% of house value that is typically lost when a house forecloses (according to Ron Morgan, a managing director at ISGN Technology's third-party servicing company, MortgageHub).  So if you multiply 500,000 * $125,000 * 20 you get $1.2 trillion dollars.   That's how much is in play.  Now, let's be generous and say that only 10% of the houses that could foreclose do, that still leaves $120 billion dollars of financial damage hanging out there.  Bank stocks have been getting killed for writing off a couple billions dollars in assets.  What happens when we start talking tens of billions?

2.   The banks money-making machines are over.  Banks, hedge funds, and private equity shops have grown fat on the cheap money and liquidity provided by the CDOs and mortgage backed securities.  They have been able to use the money to do every bigger deals and to arbitrage currencies (see my article on the Carry Trade for some insight into this).   But that cheap money is gone.  The credit markets are shut, wiping out cheap, easy access to the funds needed to do leveraged buyouts.  In addition, currency markets have responded by sinking the dollar, making the kind of arbitrage that has padded the bottom lines of banks increasingly difficult.

We all know what has happened since I wrote that article.  And today, a more reputed economist, Nouriel Roubini, from RGE monitor.com confirms that my initial estimate of 1.2 trillion wasn't ridiculous, but was rather too low.

He believes that the Fed is going to have to cut rates more which I'm not sure I agree with.  I believe there are other mechanisms the Fed can use to prop up the banks and provide liquidity to the markets.  There is also a real danger of inflation which the Fed  can't ignore.  And if Europe begins to raise rates as it has indicated it will eventually, the Fed will have no choice but to keep rates as they are or to even think about raising them.

Roubini doesn't like the stock market, the dollar, commodities, etc. and believes that inflation adjusted bonds may be the only decent investment at the moment.

It's clear that the markets are far from having recovered.  While we may have been in the first inning when I wrote the original article, it seems like we have entered the fifth or sixth inning now.  Perhaps it will be time for a stretch soon.