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Have Wall Street banks gone subprime at the wrong time?

Wall Street is praying that the US economy will land softly now that the Federal Reserve has pricked the housing market bubble, because it will be bad news for mortgage origination if house prices stall for long or, even worse, fall. Already there are early signs of credit deterioration in some of the riskier mortgage securitizations. It can only be a matter of time before subordinated CDO tranches start to take a hit. Alex Chambers reports from New York.

INVESTMENT BANKS HAVE rushed to buy subprime platforms this year. Merrill Lynch bought a mortgage unit called First Franklin for $1.3 billion, and Morgan Stanley purchased Saxon Capital for $700 million. European banks have jumped on the subprime bandwagon; this summer Deutsche Bank paid $429 million for Mortgage IT and Barclays Capital paid Wachovia $469 million for HomEq Servicing.

It appears to be a logical, if somewhat belated, reaction to the runaway success Lehman Brothers and Bear Stearns have enjoyed in their fixed-income franchises from having integrated mortgage origination businesses. And yet the very fact that, for first time in many years, subprime platforms are in play indicates that opinions are mixed on the future for mortgages.

“The reason the investment banks are so interested is that franchises are actually on the market and they’ve seen the success of the people that were out in front of the curve,” says Michael Poulos, director, North American banking practice, at Mercer Oliver Wyman. “All the players are saying ‘this is a big part of the market, we like the securitization business and we need to be able to deliver this product to our fixed-income investors. And we want to lock up some sort of proprietary sources of product so we are not always out in a competitive bid situation for every loan package.’

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