Big banks say storm subsiding

NEW YORK -- Wall Street brokerages put on a united front last week when it came to the credit crisis: the worst is behind us, and business is going to improve. But outside their boardrooms, not everyone is convinced things have turned around.

Chief financial officers from the big investment banks seemed to be reading from the same script. Lehman Brothers' Chris O'Meara proclaimed "the worst of the credit correction" is behind Wall Street; Morgan Stanley incoming CFO Colm Kelleher said "the worst is over," and Bear Stearns' Sam Molinaro added "the worst is largely behind us."

But there is a growing chorus that recession still lurks, even with a recent Federal Reserve rate cut -- and that the investment houses are still vulnerable to credit market disruptions, despite their protestations to the contrary.

"If the worst is over, then why did the Fed lower rates 50 basis instead of the 25 that the market was expecting?" asks Hugh Moore, a partner with Guerite Advisors. "We had a huge loss of confidence in the markets, and I'm not sure you can give the all clear when there's still so much uncertainty."

Indeed, former Fed chairman Alan Greenspan said the chance of a recession will linger as home prices slide and hurt consumers. President Bush acknowledged on Thursday that the U.S. is in "some unsettling times."

The amount of adjustable rate mortgages up for reset is set to peak this fall, with an estimated $50 billion worth poised to adjust to higher rates in October. The number of borrowers whose mortgage payments jump in October, November and December will be the second-highest ever for a quarter, according to a report by Credit Suisse Group.

Meanwhile, investors continue to shy away from leveraged loan debt. During the quarter, Goldman Sachs Group Inc., Bear Stearns Cos., Lehman Brothers Holdings Inc., and Morgan Stanley combined to mark down some $4 billion of investments -- most from troubled loans.

And the credit markets continue to be unsettled. Harman International Industries Inc. said Friday that Kohlberg Kravis Roberts & Co. and GS Capital Partners walked away from their $8.1 billion buyout deal. It was the latest in a string of private equity deals gone sour as borrowing has dried up.

A person familiar with the deal said the private equity firms backed off the deal because of concerns about Harman's financial health. The person asked not to be named because he was not authorized to speak publicly about the deal.

But the deal's collapse shows private equity has become less bold in the current environment.

"I think we're going to have more negative headlines, if for no reason than the mortgage resets coming in the next few quarters," said Joe Balestrino, a portfolio manager at Federated Investors Inc. that manages $21 billion of fixed-income assets. "At a minimum, the investment banks are somewhat limited in their use of capital -- much of it tied into hung deals."

Investors felt much the same way. Shares of the U.S. investment banks -- down, in some cases, more than 20 percent on the year -- failed to get the bounce some had expected once they tried to spell out the extent of their exposure to leveraged loans and mortgage-related securities.

Morgan Stanley reported profit fell 17 percent; its shares are down about 3 percent this week. Lehman Brothers gained 6 percent this week after it reported quarterly profit fell a smaller-than-expected 3.2 percent. Bear Stearns retreated about 1.5 percent since it unveiled profit tanked 62 percent.

Goldman, on the other hand, rose almost 14 percent this week. The world's largest investment bank was the only one to come out almost unscathed from the market turmoil, turning in a 79 percent profit gain.

Regardless, Guerite's Moore said the extent of the damage that tighter credit will inflict on the investment firms won't be known for quarters. "It is going to take some time to work these things out … you're going to need more transparency before people begin to step out," he said.