US and City investment banks fear profits slump

LEADING City and Wall Street investment banks fear a dramatic slump in profits over the next six months, as the bonanza conditions of last year give way to a much more difficult trading environment.

Goldman Sachs, the New York investment bank, was forced into the unprecedented step last week of formally denying that it had suffered dramatic losses on proprietary trading in London of Japanese and European bonds. Goldman came under pressure from large corporate clients to publish the statement after speculation mounted of mass sackings and the possibility of fraudulent trading.

One rumour had traders being led away in handcuffs.

The US investment bank said the speculation had probably been caused by a number of large clients liquidating bond positions last week in the wake of the recent rise in US interest rates.

However, it is thought highly likely that profitability at Goldman, which made net profits last year of dollars 2.5bn ( pounds 1.6bn) and paid 100 of its London staff bonuses of more than dollars 1m, has been dramatically reduced. Securities houses have found it much more difficult to make money out of proprietary trading this year.

While Goldman insists that its activities are under control, inquiries by the Independent on Sunday have uncovered big losses made in the financial markets since the beginning of the year, following sharp reversals in European and American bond prices. Some 'hedge' funds, which have made huge amounts of money taking bets on the directions of markets, were also said to have taken large losses.

One authoritative source said that some US hedge funds had lost as much as 6 per cent of their value on exceptionally bad trading days. Most had recovered this, he added, but at least one was still down.

Both the proprietary traders at banks, who trade the banks' capital, and the managers of the giant hedge funds, usually based in the United States, often take massive bets on the direction of markets.

According to John Lipsky, chief economist at Salomon Brothers, the good times are over. 'It is only reasonable to expect that market moves will be less predictable and perhaps less dramatic than the sharp - almost unprecedented - bond market rallies of the last year or so. But that being said, the fundamental forces of slow and disappointing growth and falling inflation in most continental European countries still create a favourable fundamental background for European bond markets. The risks are essentially policy risks and political risks,' he said.

The impact of sizeable movements in gilt-edged stock on key market players has attracted the attention of the Bank of England in its twin roles as arbiter of interest rates and protector of orderly markets. A Bank spokesman said: 'We look closely at what causes gilt-edged stock prices to move, and we monitor the positions of gilt-edged market markets on a daily basis.'

Goldman firmly denied rumours that a number of traders had been dismissed or that its offices had been visited by fraud squad officers.