Credit Mess Weighs on Banks

Editor's note: The credit markets have been the epicenter of volatility on Wall Street throughout the second half of 2007. Falling home prices and subsequent defaults on mortgage-backed securities led to a liquidity crisis that's expected to get messier in 2008. The outlook for companies in the financial sector and beyond is dim as corporate profits weaken amid a weakening economy and rising inflationary pressures. This is the third installment in an ongoing series about how the tumult in the credit markets will affect the economy and the markets in 2008.

The 2008 landscape will be markedly different for big investment banks and brokerages that were once swimming in profits but are now scrounging for cash in the wake of a subprime-inspired collapse in credit and confidence.

What a difference a year makes. At this point last year, JPMorgan(JPM - Cramer's Take - Stockpickr), Goldman Sachs(GS - Cramer's Take - Stockpickr), Merrill Lynch(MER - Cramer's Take - Stockpickr), Citigroup(C - Cramer's Take - Stockpickr), Morgan Stanley(MS - Cramer's Take - Stockpickr), Bear Stearns(BSC - Cramer's Take - Stockpickr) and Lehman Brothers(LEH - Cramer's Take - Stockpickr) were enjoying soaring profits on the heels of an unprecedented leveraged buyout boom, and they were fashioning mortgage debt in every conceivable way.

Fast forward to now, as most big banks experienced significant year-over-year declines in their share prices, including falls of more than 40% for Bear, Citi and Merrill stock. Some firms, such as Citi, Merrill and Morgan Stanley, are unseating top-flight executives and turning up, hat in hand, to foreign buyers at an amazing clip after writing down billions in mortgage securities and leveraged loans. And analysts, who are still readjusting expectations for just how large mortgage-related writedowns ultimately will be, are hesitant to call a bottom to the credit-related woes.

On Christmas Eve, three days after news first broke, Merrill officially announced that Temasek Holdings, a Singaporean state-owned investment company, was purchasing $4.4 billion of shares, with an option to buy $600 million more in the broker. The U.S. money management firm Davis Selected Advisors would buy a stake worth about $1.2 billion.

Merrill also said it would unload its financing unit Merrill Lynch Capital to an arm of General Electric(GE - Cramer's Take - Stockpickr) for an undisclosed amount.