Bond insurer, economic woes to feed fresh credit turmoil

LONDON, June 24 Tue Jun 24, 2008 9:17am EDT

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LONDON, June 24 (Reuters) - More credit turmoil is yet to come as further problems emerge, including a massive shift in risk from bond insurers to banks, and fresh macroeconomic risks, leading bankers and investors said on Tuesday.

Global stock and credit markets have suffered in June as sentiment has worsened, with the tone darkening this week as fresh worries about the financial system have emerged.

The FTSEurofirst 300 .FTEU3 hit a three-month low on Tuesday, while the iTraxx Europe ITRAC5EA= credit derivatives index flirted with the 100-basis-point barrier for the first time since April.

"For most of the year we have seen a market contraction which is the result of over-leverage," Jan Pethick, Merrill Lynch's MER.N chairman of debt capital markets for Europe, the Middle East and Africa, said at the Euromoney Global Borrowers and Investors Forum in London.

"Now we are in for another dose," he said, as risk held by the monoline insurers could fall back on the books of the banks.

Moody's Investors Service last week dished out multi-notch downgrades to MBIA Inc (MBI.N) and Ambac Financial Group ABK.N, formerly rated triple-A.

Analysts have warned that the downgrades could set off fresh turmoil -- with some saying it could be worse than March's sell-off, when Bear Stearns neared collapse.

One of the main conduits for losses from the credit crisis has been on complex structures known as collateralised debt obligations (CDOs). Some firms, such as Merrill Lynch and UBS UBSN.VX, built up big holdings of these structures and then had to take billions of dollars of writedowns on them.

"The big assumption was that the banks could hedge them and that hedging devices would offset the risk," said Pethick. "We have found that these devices were not perfectly hedging our risk exposures ... It's a wake-up call."

One route to hedging was to buy CDO insurance from a monoline insurer -- deals that banks and the insurers are now seeking to unwind, the Financial Times said this week.

"We didn't know the full consequences of what we were dealing with ... the monolines are not going to be as robust as we thought," he said.

ECONOMIC WOES

Beyond the financial sector, the global credit crisis has left the U.S. economy teetering on the brink of recession, with fears now building that problems could spread elsewhere, speakers at the conference said.

As the U.S. economy suffers, "we don't see where there will be another engine of growth," said Rene Karsenti, executive president of the International Capital Markets Association.

So-far resilient emerging markets could suffer too, spreading the pain from the credit crisis.

"The shoes to drop could be in some emerging markets," said Louis Gargour, chief investment officer at LNG Capital, mentioning Argentina and Iceland in particular.

He also cited India's inflation of 11 percent and GDP growth of 9.2 percent as unsustainable.

"The other question is when does the European economy go into recession?" he asked.

Gargour and Larry Elliott, economics editor of UK newspaper the Guardian, identified Spain, Ireland, Italy and Portugal as being particularly vulnerable to a slowdown.

(Reporting by Jane Baird, writing by Richard Barley; editing by Elaine Hardcastle)

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