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Thursday, 5 June 2008

Subprime debacle may spark 2-year credit recession

By Walden Siew

NEW YORK (Reuters) - A "credit recession" sparked by the U.S. housing market downturn and excesses in structured finance may last more than two years, and the financial sector will undergo "massive consolidation," leading Wall Street strategists said on Wednesday.

The fallout from deteriorating subprime mortgages and the broader housing and credit crisis will eventually lead to a healthier market, but not until after a prolonged purging process, Jack Malvey, Lehman Brothers Holdings Inc's (NYSE:LEH - News) chief global fixed-income strategist, said in New York.

"We're going through a tough spell with regard to credit," Malvey said at a Securities Industry and Financial Markets Association conference.

The "subprime debacle" due to years of excess and easy credit will be followed by years of tight credit, Malvey said.

Malvey spoke a day after his company's stock plunged to close at nearly a five-year low on concern that Wall Street's smallest surviving major brokerage may need to raise more capital. On Wednesday, the Wall Street Journal reported that Lehman is seeking capital overseas.

Malvey said global diversification will be a "good remedy" for investors seeking to offset losses from the downturn. "This is the biggest blowup that we've had," the strategist said.

Financial shares have been among the worst performers this year. After yesterday's declines, Lehman shares rose 6.1 percent on Wednesday to $32.53. Merrill stock climbed 1.2 percent to $42.40.

Financial earnings have suffered due to exposure to so-called structured finance debt and collateralized debt obligations, repackaged bonds whose underlying securities may be based on assets such as risky subprime mortgages.

Investment manager Loomis Sayles, one of the biggest U.S. bond fund managers, has been buying Lehman debt over the past several days, its vice chairman said on Wednesday.

"The credit is good at Lehman," said Dan Fuss, vice chairman of Boston-based Loomis Sayles, which oversees more than $100 billion in fixed-income securities. Lehman's common shares, which fell 18 percent over three days, are "dirt cheap," Fuss said.

"MASSIVE CONSOLIDATION"

Richard Bernstein, chief investment strategist at Merrill Lynch & Co Inc (NYSE:MER - News), said that in the last market cycle downturn, about 25 percent of financial firms -- including brokers, banks and asset managers -- "went away," he said, referring to bankruptcies or mergers and acquisitions.

Only 7.0 percent of financial firms have failed or been acquired so far in this crisis, Bernstein said.

Like Lehman, Merrill's earnings have suffered due to structured finance.

Bernstein also faulted U.S. government proposals to broadly modify U.S. mortgages, which may create a "moral hazard" that encourages future risky behavior, he said.

"Washington is misguided in focusing on mortgages," Bernstein said. The federal government should focus on "job creation and people keeping their jobs," Bernstein said. "That is the key to rectifying this situation."

Five-year credit default swaps on Lehman Brothers widened by about 17 basis points to 275 basis points, or $275,000 a year for five years to protect $10 million of debt, according to data from Phoenix Partners Group.

Lehman Brothers' bond spreads widened about 10 basis points overall, according to traders.

(Additional reporting by Jennifer Ablan and Dena Aubin;)

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