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Credit crunch cost $3-4trn – JP Morgan

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GLOBAL - JP Morgan officials say investment market turbulence sparked by the US subprime housing crisis may already have cost in excess of $3trn (€2.04trn) in lost credit and warn there could be more to come under tightened credit pricing.

Chris Flanagan, head of global ABC and CDO research at JP Morgan, told delegates at the Institutional Fund Management in Geneva the US housing market is likely to fall a total of 25% by 2010 before moving upwards again while pressure on fixed income product pricing is likely to decrease potential returns on investments in ‘good' credit paper.

More specifically, Flanagan presented calculations made by his firm suggesting the true physical cost of the credit crunch is likely to be in the region of $337bn to the banks involved, as $100-150bn has been declared as write-downs, a further $50-60bn in fresh capital has been injected by external investors, such as sovereign wealth funds, but it is thought only 75% of the true costs has been revealed - creating a potential cost of £337bn.

This figure was obtained by estimating - through figures currently available in the market - the losses seen through exposure to US prime and commercial mortgages as well as car financing and credit, and then increasing the potential impact as credit availability has tightened so much the actual value of 'lost credit' is in the region of 12 times this figure, or $3-34trn.

While there is no clear physical evidence of this '12x' credit tightening, the drying-up of credit liquidity has meant cancelled flotations, pressure on private equity financing deals and similar moves stifling corporate activity since August 2007.

According to Flanagan, while credit markets have improved somewhat to carry potential exposure risks, the continuing unwillingness of firms to take risk with wholesale and institutional borrowing means any apparent benefit to being invested in high grade debt could be "quickly wiped out" as discounts on corporate bonds are bringing down coupon guarantees.

"As home equity-driven consumption contracts, so credit availability will also contract and this will pressure on prices. But spreads are at the point where bad news is fully priced in," said Flanagan.

"Returns over Libor for AAA and AA bonds still look OK. But with AAA priced at 68, instead of 72, the 5.5% coupon could be quickly wiped out. As attractive as certain assets and bonds can look, we have a major pressure under way which will put wide pressure on asset prices for an extended timem," he added.

At the same time as suggesting bond markets would continue to see pricing pressure, Flanagan was firmer in his projections for the US housing market, arguing residential real estate prices in key coastal regions have already been hit on the back of leverage softening, and will fall 25% before the market rebounds in 2010.

"Global real estate prices are beginning to soften, and leverage play with it. US housing has 10-15% to clear before it bottoms out by 2010. Since 2003, the housing market rose 60%, but it is already down 11%."

He continued: "When it comes to the status of new and existing homes, Lennar's properties sold a huge holding to Morgan Stanley at 60% off prices in November. Prices are expected to move down at least 10-15% in 2008 and 2009 and there will be no bottom in prices until 2010. Builders will cut prices first and homeowners will assume everything is still OK.

"Key markets to focus on are California, Nevada, Arizona and Florida and Louisiana. These are the markets now experiencing declines after being overheated. Since January 2006, Texas, in contrast, has benefited from the energy boom. But the speculative coastal markets are taking the hit," he added.

In January, JP Morgan signed a joint venture agreement with Apartment Investment and Management Company to gain a co-ownership of three apartment complexes in West Los Angeles. (See an earlier story from sister publication IPE Real Estate: JP Morgan creates $726m apartment JV

If you have any comments you would like to add to this or any other story, contact Julie Henderson on + 44 (0)20 7261 4602 or email julie.henderson@ipe.com

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