Buyouts and Shakeups: How the Financial World Is Changing

Obviously, the world of banking/finance has changed dramatically in the last 12-14 months, so let's quickly look at the major changes:

• The Mortgage GSEs are now under government control, and their shares are now trading for pennies on the pink sheets.
• We started the calendar year with five major independent investment banks and are now down to two. Merrill Lynch (MER) and Bear Stearns (BSC) were saved from collapse via buyouts, and Lehman (LEH) was forced to file for bankruptcy. Only Morgan Stanley (MS) and Goldman Sachs (GS) remain.
• In the mortgage lending space, the country's largest mortgage lender was saved from disaster via being bought out by Bank of America (BAC) for roughly $4 billion - a steep discount for a company that was worth over $20 billion at the beginning of 2007.
• IndyMac was shut down by the FDIC in the largest bank closure since 1984. In fact, the size of the IndyMac closing ($32 billion in deposits) exceeds the size of all banks closures in the last 15 years by nearly 50%. The IndyMac closing (according to the FDIC) has the potential to be the most expensive bank failure in history.
• In the last nine months, there have been over 3X as many bank failures as there had been in the previous two years, and the FDIC faces a potential shortfall as a result.
• It's almost a guarantee that AIG (AIG) is going to collapse if the company isn't able to raise additional capital, and both Washington Mutual (WM) and Wachovia (WB) are facing significant struggles of their own.
• The FDIC faces a potential funding short-fall due to the recent bank failures.

What makes all of the above especially significant is that they have all occurred within the last nine months - with the GSE takeover, Lehman bankruptcy and Merrill Lynch buyout all happening within the last 10 days.

So much for the cry of "subprime containment" that certain individuals were preaching (still) at around this time last year.

Does all of this mean that we're on the precipice of a financial cataclysm? Not in my view (and it's no secret that I tend to lean towards the bearish side of things). We still have areas of strength left within the nation's financial system, however all of the above are symptoms (if not extreme symptoms) of what is turning into the largest banking shake-up since the Great Depression.  While the current times may not exactly be pleasant, they're undoubtedly historic and on a magnitude that's rarely witnessed. The events of the past year simply don't fall into the realm of typical failures, mergers and buyouts.

Things already look markedly different and the banking crisis has yet to fully run its course. Three, five or ten years from now, the banking environment will certainly be unrecognizable in comparison to how it looked at the beginning of last year.

Sources:

The WSJ: "FDIC Weighs Tapping Treasury as Funds Run Low" -- Damian Paletta and Jessica Holzer, August 27, 2008.

CNNMoney.com: "Regulators size troubled IndyMac" -- Catherine Clifford, Chris Isidore, July 11, 2008.

The WSJ: "Old School Banks Emerge Atop New World of Finance" -- Carrick Mollenkamp, Mark Whitehouse.

Disclosure: The author doesn't own a position in any of the companies mentioned in this article.

Comments

[RCK:]

You are right. Capital world is reshaping itself. To those who whine that taxpayers money should not be used for bailouts, I say. come on guys, WAKE UP AND SMELL THE COFFEE". Throw away the cloak of 1800's capitalism. You are still trembling in the memories of 1929. Downing of AIG would have been a tsunami the world over. Nobody has yet jumped out of wall streets windows. If AIG is to go under, it will, no matter what but in an orderly way. taxpayers money is going nowhere. It will comback to taxpayers.

2008 Sep 17 09:10 AM

[No Moss:]

The role of the GSEs made them incredibly vulnerable. Although they have been saved, it's unlikely that they will resume their role as freely as before, meaning that commercial banks will take up more of the "burden" of mortgage lending. Without mortgage guarantees, money will be tighter and loans will have higher standards and bigger down payments. Securitization will be reduced. The clear beneficiaries of this will be commercial banks, who have large deposit bases to use as a source of loans (in the absence of securitization).

Homes will be harder to finance, but worthy borrowers will still be able to get a home loan. Savings rates will go up as people save for down payments, home prices will stabilize to modest appreciation, dampening the rampant speculation that made them so unafforadable in the first place. HELOCs will be reduced as equity climbs more slowly. Things will return, for a time at least, so a slower, more stable pace.

Securities will replace homes as the investment vehicle of choice, and the stock market will go up.

It's not a new world, we're just going to rearrange things a bit.

2008 Sep 17 10:36 AM