Lehman Is Just the Thin Edge of the Wedge 28 comments
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[The following is excerpted from Bill Cara's Week-in-Review]
Last week was all about the probable demise of Lehman Brothers (LEH) and the questions and concerns of traders as to how the monetary authorities and banking industry would resolve it.
The Lehman situation has been dogging the market for some time, but whatever was going on behind the scenes with respect to attempts to sell equity or assets must have blown up after the close on Tuesday, because spreads on the Lehman debt exploded (meaning nobody would buy their debt). LEH plunged -77.5% last week. That situation became a replay of the Bear Stearns sudden death spiral where in a very few days, that once great company died.
Lehman is a much bigger name and more important to the smooth functioning of the credit ring than Bear Stearns, so traders began to panic. In what is referred to as the safe-haven trade, money quickly flowed into Treasuries, knocking down yields.
Although the monetary authorities were clearly trying to support the $USD on Wednesday and Thursday, traders also followed through by selling the Financials and rotating into the Energy and Basic Material sectors, which are basically Dollar hedges.
Finally on Friday the $USD plunged -1.6%. Sensing this, I recommended a purchase of Goldcorp (GG) on Thursday, and on Friday that stock rallied +13.7%. Barrick (ABX) was up +11.0% on the day as well.
But, as I write this WIR, there is no word as to how this Lehman situation will be resolved. The problem is much bigger than Bear Stearns, which cost the US Treasury guarantees of $30 billion, which likely will never be repaid. Lehman might cost double that, and frankly the public will not put up with it.
Moreover, Lehman is just the thin edge of the wedge. Other financial giants like Wachovia (WB) -14.8% W/W, Washington Mutual (WM) -36.1%, Merrill Lynch (MER) -36.2%, and AIG (AIG) -45.7%, for instance, are also looking very much like they are in distress and will need a bail-out. Since when have the biggest financial companies in America dropped so far, so fast?
In fact, why stop there? If every financial services company that is presently holding supposedly asset-backed debt instruments in inventory were to value those holdings at real cash market prices, there would be devastation across the board. Maybe a trillion dollars around the world – half in the US apparently – would need writing down, and that would result in the immediate need for most of these companies to raise additional capital. The problem is that most of them could not raise capital – like Lehman on Wednesday in the debt market -- without eliminating their existing shareholder equity.
This is why about a year ago, I called many of the HB&B components toast. The companies that have raised massive amounts of capital in the past year have already seen their market caps fall far below the new capital that has been raised. But the situation has not been resolved, and the extent of future write-downs is still unknown, so private capital and other banks are now hesitating making investments.
Independent traders are sitting back, having largely pulled their capital out of this market, and asking themselves why the authorities are not letting failed companies die. People are asking why supposedly free capital markets are not being allowed to do their job. They don’t believe the explanation that the US Treasury Secretary, for instance, is working in the public’s best interest, doing what must be done to save the people’s capital.
Just to save Fannie (FNM) & Freddie (FRE), for example, will cost taxpayers how much? The Administration says $200 billion, but others are thinking $1 trillion!
At this point, most of the credibility earned by people in authority has been lost. Nobody knows what’s going to happen next.
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This article has 28 comments:
It's pretty certain little can be done to prevent a systemic collapse of many financial institutions, and, like before, the way to begin a recovery will be by printing money, which is highly inflationary. Ben is warming up the presses again and has ordered red ink this time.
Wells Fargo, which is considered one of the more healthly banks, and was snubbing this crisis as recent as July with it's remarkable 2Q report, has quietly been raising capital at 10%! They all live in a house of cards, and the winds are picking up.
The people?
The problems/rumors came back to haunt the market after the "short" rule (SEC) expiration.
It is important to note the almost geometric explosion in the open short interest in the sharesof Lehman ,followed by the "impending" demise of the company rumors .
The real question is" Why all of a sudden the subprime (misinformation) issues are resurfacing as the industry has been making the allowance for the "exposure" by taking some substantial losses"
In fact the mortgage related distortions ,have an impact on AIG ,where the real issue is exposure in the CDS market (AIG did take some substantial write offs).
More importantly ,what happened to the experts two years ago or even last year?
In an interview with Mark Gilbert(Bloomberg London ) in June of 2005 ,I have discussed the risks that we are witnessing today.
On September 18 ,2007 ,on Bloombrg TV(Brian Sullivan ,during the FED time),I have expressed my concern about the severity of the subprime issues which are about to impact the market .
It took almost two months after the the interview for the financial community to realize the severity of the problems.
Now as the market is consolidating,the financial sector is addressing the issues systematically and responsibly(with the assistance of the Tresaury ,FED, Congress and Administration),some Mega speculatorsare trying to undermine the global financial system in the name of "free Capitalism"(read we are short the market).
Once and for all the Treasury and the FED should address the speculators by sending the message to the markets that Lehman and likes will not be compelled to fail.What's next ? Citi? Merrill?.
This speculative assault on the very economic fabric needs to be stopped now .
The Bank of England had nationalized a "mortgage " banking institution in order to avoid the assault on the British Banking system.
It has worked well.The Treasury has send the same message in "nationalizing" the FRE and the FNM.
It should assist the resolution of Lehman's issues and once and for all send a message that failure of a finacial institution will not be allowed.There is always a more rational approach.
I don't want to hear about the cost of saving the viabilty of the financial institution to the taxpayers -we simlpy do not know .The future economic trend ( I am a bullish on economy and the market) will determine if in fact there will be any losses(I dont think so).In fact allowing the institution to fail may cause unquantifiable losses to the U.S and the global financial system.
As far as gold is concerned it is just a shiny piece of metal used as universal means of "exchange" from the biblical to medieval ages.
What are we going to do ?utilize 1 oz bars for day to day transactions?
For the resolution of the banking problems experts are questioning liquidity- for the public? they are recommending gold (relatively illiquid asset when compared to cash).
I continue to be bullish on the U.S markets and economy.The finacial issues have been identified and are being addressed.
The experts had proclaimed recession (we are not in one).the markets have adjusted accordingly,now they offer a relative value.
The voices of Doom are about to fail.Even the rebound in the housing market in the period ahead will surprise many.
Resolving and accomodatimg Lehman's problems? will be the step in the right direction.
Why, you raving conspiracy theorist! How dare you suggest that markets in the USA are manipulated!
"Nobody knows what’s going to happen next."
We all know what SHOULD happen next if we had free markets. Since we don't, and since no one except insiders know what the manipulators' next move is, nobody (except them) knows what to do. And that is exactly why the markets are in turmoil. Uncertainty = fear, and fear is fatal in finance. If someone would staple Paulson's and Bernanke's mouths shut, the markets could get on with an "asset reallocation" and we could start some kind of movement towards recovery. Finance is money, money is math, and math ultimately tells the truth. Truth is the first casualty of government.
GB said: "What are we going to do ?utilize 1 oz bars for day to day transactions?"
In Argentina they used wedding bands, cut pieces of gold necklaces, etc.
"The experts had proclaimed recession (we are not in one).the markets have adjusted accordingly,now they offer a relative value."
The markets haven't really even begun their adjustment, most of which has been manipulated against by the interest rate cuts, rule changes, jawboning, TAF/TSLF, and taxpayer-funded bailouts. When these stop, or when new ones can no longer be funded, the REAL market adjustment begins.
I am not looking forward to it, but it shall be what it shall be. This one is too big to be manipulated away.
Far fetched ?-perhaps....but if enough investors feel the pain, it is one way to cause a massive rally(equity indices would double) and turn the table on the shorts .
Would you allow a speculator to "short" your house(individually) because he thinks that the price of your house will go down? -I don't think so.Same principal applies here .A speculators are allowed to "short" what they do not own and disseminate distorted information.
Sounds crazy.Take a delivery of your stock and help yourself and the market.
Finally the perfect negative indicator ,Mr.Greenspan expressed his convictions that a recession is alikely outcome of the current chaos(which he seeded)- now I am convinced that it is not.
The FED should be seriously contemplating a rate cut to neutralize some of the market paralysis.
Despite all the electronic ink that has been spilled, the tax payers have become liable for Fannie & Freddie and we will, no doubt, become liable for more institutions in the future.
So, since it's a given that taxpayers will be required to bail out financial institutions that are too-big-to-fail, too-politically-well-c... or whatever, I say we turn the discussion of WHICH TAXPAYERS should be on the hook.
For example, the Fed is pleading with a number of financial institutions to get them to take over Lehman. And Lehman is just the thin edge of the wedge.
So, instead of pleading with financial institutions, the government should be considering new taxes that will make those responsible for the credit crisis pay up.
Personally, I favor a retroactive financial institution CEO tax. Let's have congress pass new tax legislation that will give the IRS the mission of leveling taxes on financial institution CEOs over the past ten years.
After we've taxed the CEO incomes, we can institute net wealth taxes on everyone who's become rich over the last ten years by running up the housing bubble.
We could start by retroactively taxing the capital gains on home sales over the past ten years. These homeowners have been the principal beneficiaries of the housing bubble, so let's let them pay their fair share for dealing with the financial crisis that has resulted from the housing bubble.
What we shouldn't do is assume that tax payers who have not gained in any way from the housing bubble should be made to pay for the mess created by the housing bubble.
Credibility IS the issue. The value of every paper asset depends solely on this.
Hank and Ben told us Fannie and Freddie are just fine. That turned out to be a lie.
Alan told us ARMs are a good thing. another lie
The SEC is supposed protect the paper markets against cheating. They destroyed credibility by implying that cheating (counterfieting stock) is OK for market makers and people who do not do this with certain paper.
A man in a cave successfully attacked 3 of the most secure buildings on the planet and is still at large and vocal 7 years later.
The common man knows a lie when not under hypnosis. (Read: watching TV)
Unfortunately for most of us, what happens next will be decided by the very liers and thieves who got us into this mess systematically and responsibly.
How Lehman is forced to unwind their trading book will have some major reverberations. Hopefully, this won’t entail a CDS tsunami and will wake up the regulators to put CDS on a public exchange like they should have at least a decade ago.
On a related note, I just watched a nervous Merrill Lynch employee run out after a long phone conversation. There are a lot of nervous people these days...
[1] Rescind SARBANES/OXLEY -- personal liability of O/D;
[2] SEC to reinstitute UPTICK RULE and Shares shorted "must be borrowed" before confirmation of trade;
[3] SEC enforce the laws on NAKED SHORT SELLERS.
Just think back to when the Bush administration was telling us that the Iraq war would only cost US taxpayers a few billion, and that it would be over quickly.
Between Iraq and Afghanistan, we're now spending $16 billion a month!
Fannie & Freddie will probably soak us for far more than a trillion, and today's financial meltdown is a wake up call - I'm not laughing at the doomsayers after today.