Credit Suisse analysts estimated banks could lose up to $52 billion over time due to their exposure to collateralized debt obligations that invested in U.S. subprime mortgages.
Most of the losses would stem from loans to hedge funds, compared with an expected $5 billion to $10 billion from banks' direct investment in subprime CDOs, the Credit Suisse analysts said in a report dated July 6.
The global financial system can absorb such losses, the analysts said, but the prospects for the subprime mortgage sector remains murky. The risks of CDO downgrades by rating agencies and further depreciation in the U.S. housing market could result in erosion in CDO values, according to the report.
Meanwhile, the analysts said European banks will suffer smaller subprime CDO losses than their U.S. counterparts.
European banks tend to be among the most conservative buyers of CDO paper and we estimate that their share of losses will be much smaller than that of the U.S. banks, they said in the report.
In June, fears of hedge fund losses in subprime mortgages, or home loans made to borrowers with blemished credit histories, rattled financial markets after news of hefty losses at two funds managed by Bear Stearns.
Troubles at several other hedge funds have came to light since Bear Stearns' fund problems: Cheyne Capital's Queens' Walk, Cambridge Place Investment's Caliber Global Investment, and United Capital's Horizon Funds.
Worries about broader systemic impact from subprime woes have kept some investors on the defensive, spurring bids for low-risk investment such as U.S. Treasury securities.
Subprime CDOs are instruments created from securities backed by subprime mortgages whose fortunes deteriorated with a spike in loan defaults and delinquencies.
Losses in the tens of billions of dollars are clearly a huge problem, but we do not think that they are a systemic one, the analysts said.