Tuesday, April 15, 2008

Crisis to affect markets for a decade: JP Morgan

Crisis to affect markets for a decade: JP Morgan By Richard Barley
Reuters Mon Apr 14, 10:48 AM ET

The financial crisis will affect market structure and pricing for at least a decade and lead to greater regulatory powers for central banks in areas at the centre of the turmoil, analysts at JP Morgan said.

"Market participants and regulators will focus intensely on controlling the risks that were at the core of the crisis," analysts led by Jan Loeys and Margaret Cannella wrote in a note on Monday.

These risks include lending standards in mortgages, leverage in the funding of securitized products, and the use of short-term financing for illiquid long-term assets outside of the regulated banking sector.

This will change behavior for market participants "for at least a decade," they wrote, in line with fallout from previous crises.

"We had the NASDAQ, we had LTCM, we had the various forms of emerging-market crises in the '90s, we had the real estate crisis of 20 years ago: In most of these the direct impact on the behavior of the parties involved lasted more than 10 years," Loeys told Reuters in a telephone interview. "It looks like it takes a generation for the memory to fade and for the same mistakes to be made again."

He noted, for instance, that global equity markets remained extremely cheap on all risk measures even five to six years after the end of the dotcom crash.

As a result of these changes in behavior, banks will become "bigger, safer and somewhat less profitable" as they will retain more assets on balance sheet, the analysts wrote.

Securitization will be reduced, and no longer rely on short-term funding structures that assumed liquidity as a given, although it will survive, they said.

Meanwhile, premia for term, liquidity and credit risk will be higher on average over the next cycle, they said.

JP Morgan (JPM.N) is regarded as having steered a relatively steady course through the credit crisis, turning a profit last year where others posted huge losses. It took centre stage in March as it announced a deal to buy Bear Stearns (BSC.N), averting a collapse that could have set off fresh turmoil in already battered financial markets.


The biggest change as a result of the crisis will be in regulation, Loeys said, with the focus on the off-balance sheet structures that the financial world has created.

"This looks like a recession caused by financial markets, which clearly policy makers are not going to take kindly to ... There will be a lot of follow-up," Loeys said.

"This was a run on the securitized world. The bank regulation and the structure of the supervisory system was created for a banking world of taking deposits and making loans. That world has moved towards capital markets, which were regulated from the point of view of consumer protection, but not from a systemic stability point of view," he said.

"Banks did not have the tools to try to protect the capital market from its own excesses."

As a result, central banks will be forced to take on more power as they are the entities extending support to the markets, Loeys said.

"Central banks' extension of liquidity to broker-dealers and (the) securitized world is permanent, and will be followed by regulatory control," the analysts wrote.

(Reporting by Richard Barley; Editing by Jason Neely)

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