Time to consider what the year ahead might have in store. Volatility and uncertainty seem to be at an all-time high making an already difficult project that much more challenging. What follows are what we believe to be the four key drivers underpinning financial affairs in the coming year.

1. U.S. Economy
Overall, we expect 2008 to be a year of lackluster performance for the U.S. economy.

• The subprime crisis will continue to unfold well into the year, but we expect a slight rebound late Q3 or early Q4.
  
• As of now we believe that the odds of a recession are less than 50%. A more likely scenario is stagflation - a period of sluggish growth and rising prices - and recent inflation data suggest that this scenario is becoming increasingly possible.
  
• We expect the dollar to remain depressed throughout 2008 in the wake of the subprime crisis and falling interest rates. Even a reversal of Fed policy, while bullish for the dollar in the short term, will in all likelihood not be enough to prop up the ailing greenback .

2. Subprime Fallout
As the subprime crisis gradually unwinds and public and private remedies take hold, Congressional scrutiny of both the mortgage industry and Wall Street will intensify.

• The 2008 election will be critical in deciding whether and to what extent these industries are further brought to task. A Democratic president and Congressional majority would virtually ensure a major regulatory overhaul of the mortgage industry, resulting in further turmoil for overwrought GSEs and their network of loan originators.
  
• Wall Street will likely emerge unscathed, unless much is made of allegations that investment banks were aggressively selling mortgage debt at the same time they were dispatching it off to investors, a practice which, if true, harkens back to conditions prior to the Global Analyst Research Settlement.
  
• We expect an explosion in subprime-related litigation in 2008 led by aggressive state AGs.
  
• Look for intense scrutiny of ratings agencies and the nature of the relationships they maintain with investment banks.

3. The Dollar
A gloomy economic outlook notwithstanding, the falling dollar will generate a marked increase in cross-border dealflow in financial services.

• The subprime crisis is providing an additional catalyst in this space as we have seen Citi, Morgan Stanley, and now Merrill Lynch as beneficiaries of Middle Eastern, Chinese, and Singaporean equity infusions, respectively.
  
• We believe that dealflow originating with Sovereign Wealth Funds (SWFs) will increase dramatically in 2008 as these funds seek to carve out new and shore up existing strategic positions both in global financial institutions and infrastructure. The latest entry: Saudi Arabia.
  
• PE activity will slow commensurate with the credit squeeze, but as the crisis unwinds and assuming interest rates remain low, an upswing in PE activity will follow.

4. Web 2.0
This business model will continue its steady infiltration of financial services.

• We expect to see increasing attention paid to social networking and its potential for financial services via P2P, virtual currencies, and micropayments.
  
• The much-anticipated rollout of Facebook's payments system will refocus its perception as a base for viable businesses.
  
• Some intriguing deals could arise out of this space as more "practical" applications are deployed across the network and monetization begins to take hold.

Wildcards
There are at least three longshot drivers which could feature prominently in financial affairs in 2008.

• Consumer Confidence - Indications are that highly leveraged consumers are falling behind on their credit card payments, with the highest delinquency increase in accounts 90 days or more in arrears. Analysts agree that the main engine of the U.S. economy is the consumer. A marked pullback in consumer spending could be disastrous.
  
• Geostrategic Tensions - Pakistan's political crisis continues with this week's assassination of Benazir Bhutto. Iran continues to present a threat to Middle East and global stability. Putin's Russia is seeking greater influence worldwide. Turkish incursions into northern Iraq are of increasing concern. Any one of these situations could mushroom into a larger crisis which could significantly impact global markets.
  
• China - The overheating Chinese economy could soon reach a boiling point. The falling dollar, while good for China Investment Corporation (China's Sovereign Wealth Fund) is bad for dollar-denominated assets. The mix of China's foreign currency reserves is a state secret, but anecdotal evidence suggests that Beijing may be close to (if not already) scaling back its purchases of U.S. Treasury securities. Further dollar losses could precipitate a strategic rebalancing of its foreign currency portfolio, a move which would have dire implications for the U.S.

Best wishes for a safe and prosperous new year.