November 9, 2007 / 4:09 PM / 10 years ago

UPDATE 2-Credit crisis worse than LTCM - Lehman's Malvey

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By Walden Siew

NEW YORK, Nov 9 (Reuters) - The U.S. credit crisis is now worse than the crisis of confidence following the collapse of Long-Term Capital Management in 1998 and recession risks are growing, said Jack Malvey, chief global fixed income strategist at Lehman Brothers.

In 1998, investor confidence was shaken after deep losses resulted in the collapse of Long-Term Capital, which spurred the Federal Reserve to initiate a bailout of the hedge fund to avert a wider financial collapse.

“This is the deepest correction we’ve ever seen in structured finance,” Malvey said in an interview on Friday. “This is now worse than Long-Term Capital.”

“This is so dispersed, so interlocked and the relationships among the various entities are not as evident,” Malvey said in New York. “This is a painful lesson in financial engineering.”

U.S. Treasury debt prices rose for a fourth day, while stocks fell on Friday after Fannie Mae FNM.N, the biggest U.S. mortgage finance company, said its quarterly net loss doubled, and Wachovia Corp WB.N, the No. 4 U.S. bank, warned of losses. For details, see [ID:nN09339219]

One-month dollar/yen implied volatility, a gauge of investor fear about greater risk in the foreign exchange market, is on pace for the biggest weekly increase since early October 1998, when LTCM was blowing up and the global economy was still reeling from Russia’s sovereign default.

While Lehman now assigns a 30 percent probability of the U.S. falling into recession next year, risks may be growing, Malvey said.

“There’s a lot of recession risk denial in the marketplace,” Malvey said. “We will find out over the next three to six quarters if we are coming close to recession or may cross over the recession line.”

The collapse of Bear Stearns hedge funds in July has been followed by massive bank write-downs that have even surprised veteran bond and market analysts.

Losses are so bad that many firms are reporting additional losses just a few weeks after publicizing huge write-downs. Citigroup (C.N) said this week it expects as much as $11 billion in losses from its exposure to bad mortgages tied to collateralized debt obligations, or CDOS. A month ago Citi said it cut the value of those assets by $5.9 billion.

Merrill Lynch & Co. MER.N last month announced a $7.9 billion write-down, up from $4.5 billion just a few weeks earlier.

“This sort of staccato reporting of write-downs is something with financial services that we haven’t seen in quite a while, not since the S&L crisis,” Malvey said, referring to a wave of U.S. savings and loan association failures in the 1980s, which were followed by a U.S. recession.

Editing by Andrea Ricci

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