Credit Suisse Prediction: With US Default, Stocks Drop 30%, Economy Contracts 5%

According to Credit Suisse, worries about US public finances will likely bring investors to focus on ultra-safe equities.

(July 28, 2011) — A new paper by Credit Suisse predicts that in the unlikely event that the United States defaults on its debt obligations, stocks would drop 30% and gross domestic product would fall 5%.

Furthermore, the report asserts that worries about public finances in the United States will likely bring investors to focus increasingly on ultra-safe equities.

The chance of a rating downgrade on US sovereign debt could happen even if the debt ceiling is raised, the report said. Yet, expressing confidence that a ratings downgrade would not lead to disaster, the firm wrote in its paper: “We think there is a 50% chance of a ratings downgrade on US sovereign debt. This could happen even if the debt ceiling is raised. We doubt it will have much effect.”

Additionally, the report predicted that if no budget deal is struck, but the US fails to default, stocks and the economy will experience difficulties. “It is almost unthinkable to believe that the US would miss a coupon payment ($29 billion is due on August 15th),” the report stated. “If the US does default, there are massive ramifications. According to Credit Suisse chief economist Neal Soss, the repo market would probably cease to work. It is hard to imagine money market funds operating under this scenario. The inter-bank market would freeze up. The fallout would be far worse than after the Lehman’s default. Back then, the US government could at least spend and do the ‘right thing’, while now the only back-stop would be the Fed.”

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Rating agency Moody’s recently suggested complete elimination of the debt ceiling. “We would reduce our assessment of event risk if the government changed its framework for managing government debt to lessen or eliminate that uncertainty,” Moody’s analyst Steven Hess wrote in a report.

Last week, the rating agency cautioned that it would slash the US’ AAA credit rating if the government misses debt payments. It noted that because lawmakers have acted to increase the debt ceiling, it had not previously considered the situation high-risk.



To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

In Latest Post-Crisis Lawsuit Ruling, Judge Upholds Suit Against Lehman

A judge in Manhattan District Court has rejected a bid by former Lehman Brothers executives and affiliates to dismiss a case alleging misleading practices, as the lawsuits that investors have filed against financial institutions continue to creep forward.

(July 28, 2011) – A federal judge in Manhattan District Court ruled yesterday that the most serious allegations in the lawsuit of investor losses brought against former Lehman Brothers Holdings (Lehman) executives will move forward, the New York Times has reported.

The suit, which was filed in 2008, is one of a number of suits filed by investors against financial institutions in the wake of the financial crisis. The five leading plaintiffs in this lawsuit are the Alameda County Employees’ Retirement Association, the Government of Guam Retirement Fund, the Northern Ireland Local Government Officers’ Superannuation Committee, the City of Edinburgh Council as Administering Authority of the Lothian Pension Fund, and the Operating Engineers Local 3 Trust Fund.

The defendants in the case include former Lehman CEO Richard Fuld Jr. and former CFO Erin Callan. The remaining defendants are other former Lehman executives, a number of Lehman underwriters (among them, UBS, BNY Mellon, and BNP Paribas), and Lehman auditor Ernst & Young.

The lawsuit alleges that the defendants misled investors about the firm’s accounting and risk management practices. More specifically, the suit alleges that Lehman’s use of Repo 105 transactions – repurchase agreements that allowed short-term loans to appear as sales – made it seem that the firm was less leveraged and in a better financial state than it truly was, according to the Wall Street Journal.

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Judge Lewis Kaplan explained his decision to reject the bid filed by defendants to dismiss the case: “It is entirely plausible to conclude…that the misleading picture that Lehman portrayed played a material part in keeping its stock higher.” As a result, he ruled that the main accusations of the suit will stand because some of the investors’ losses may be “attributable to the alleged fraud.” The judge did throw out some minor allegations against the Lehman executives and underwriters as well as the majority of the allegations brought against Ernst & Young, the WSJ reported.

In February, aiCIO reported that the California Public Employees’ Retirement System (CalPERS) was suing former Lehman executives and underwriters, alleging the same infractions as the plaintiffs in the most recent ruling. According to the Los Angeles Times, CalPERS owned 3.9 million shares of Lehman common stock as well as around $700 million of the company’s bonds when the former financial giant filed for bankruptcy in September 2008. There has been no further ruling on the case.

The CalPERS suit, which was filed in US District Court in San Francisco on February 7, was later transferred to Manhattan District Court and assigned to Judge Kaplan. The cases, however, remain separate.



<p>To contact the <em>aiCIO</em> editor of this story: Justin Mundt at <a href='mailto:jmundt@assetinternational.com'>jmundt@assetinternational.com</a></p>

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