Lehman Is Just the Thin Edge of the Wedge

 |  Includes: AIG, MER, WFC, WMIH
by: Bill Cara

[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 (NYSE:GG) on Thursday, and on Friday that stock rallied +13.7%. Barrick (NYSE: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 (NASDAQ:WB) -14.8% W/W, Washington Mutual (NYSE:WM) -36.1%, Merrill Lynch (MER) -36.2%, and AIG (NYSE: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.