Obama is Bush part 3

Debating the Lehman Collapse

riskyreward -- there are a lot of problems with the "Spinco" idea
(1) You have to be able to place a "real" value on the spun off assets. That involves some sort of price discovery (aka "mark to market"). By definition, there is no widespread agreement on the value of these assets -- meaning it will be almost impossible to make "Spinco" be bankruptcy remote. The creditors of "Spinco" will have a firm legal claim on the assets of the surviving portion of the company.

(2) The market value of many of these companies suggest that the losses on "Spinco" exceed the positive value on the otherwise surviving businesses. That's a fancy way of saying the remainder of Lehman isn't going to survive

(3) There is no way to create a stable system in which the rewards go to the lucky / politically connected -- but the costs are born by "the system" (aka the taxpayers). Whether anyone wants to admit it, the parts of Lehman that might survive benefited tremendously from the parts that are now causing its demise. Why should the "surviving" parts benefit doing good times, but not suffer during bad times? And why on Earth are the rest of us responsible for their mistakes?

Every little hot dog vendor on the street is not "too big to fail". No matter how entangled Lehman is with the rest of the street -- everyone has known about the Lehman problem for months. Any firm that did not control their exposure over those months deserves to fail.

Arguably some of the most prominent firms on Wall Street 30 years ago were names like White & Co, EF Hutton, Loeb, Salomon Brothers, and Paine Webber. They were all as important in their day as Lehman or Morgan Stanley is to today's market. They are all gone -- and the world did not end. Drexel Burnham failed almost overnight, and again the world did not end. Even the junk bond market is still alive and well. The world will miss Lehman and many others that will soon fail -- but life will go on.

There will be a disruption when Lehman fails, but it won't bring down any well managed firm... The CEOs of the other companies are **SUPPOSED** to be doing daily credit analysis on all their counterparties. They have all had months to adjust to the current crisis. If they haven't adjusted, if they aren't doing their jobs, then they deserve the fate of any business that isn't doing its job.

Things will stabilize when trust and confidence is restored to the system -- not when a bunch of government bureaucrats and central economic planners pick and chose which firms will survive or fail based on politics.

Firms that don't do their job well have always failed -- except in crony capitalist economies where government props them up. Consumers and taxpayers are always worse off when this happens.

The best solution to this problem is the one the U.S. suggested (and almost imposed) on Asia 10-15 years ago... Don't prop up bad businesses; instead let new entrepreneurs step in and meet consumer demands. Get government spending under control.

Lots of people have tried to blame free markets for this crisis... but if we were more honest: it was the Fed that lowered interest rates too far. It was Alan Greenspan (the Fed again) that recommended everyone switch to adjustable rate mortgages, and it was bank regulators that failed to regulate banks on liar loans and abysmally poor (non existent?) risk management practices. Government's push to promote home ownership -- at any price-- was a big part of the problem. Fannie Mae and Freddie Mac are both political entities sponsored by the government.

If taxpayers go and bail out the failed companies (which we really cannot afford to do anyways) -- it means the same geniuses that caused this problem remain in business to mess things up again and again. The economy needs new companies with new ideas and better management -- those new companies will never come to be if they have to compete against government/taxpayer subsidized ponzi schemes. Part of the reason why Fannie and Freddie got so oversized is because they had implied government backing and could borrow money 80 basis points cheaper than the competition (and according to a Federal Reserve study, less than 25bp of that was passed along to homeowners).

People always want to take action and "do something!!!" -- but sometimes the best thing to do is nothing. Have a little patience. This too shall pass.

Debating the Lehman Collapse

riskyreward -- I think I understand your point now.. but I still disagree. Accounting has ALWAYS been an art, not a science. You cannot look at book value or P/E ratios as if they were some sort of precise measurement. At best, they are a snapshot of a moving target. At worst, they are nothing more than artifacts of accounting rules.

People have been debating the merits of "mark to market" and "cost basis" literally for centuries (the concepts were the same, the names sometimes changed).

Mark to market gained popularity precisely because cost basis does not reflect impaired value unless and until management "recognizes" it. Plenty of CEOs have inflated earnings by simply delaying that "recognition". Mark to market regained popularity because CEOs would pretend acquisitions were successful -- there are many instances from the 1980s were a CEO overpaid for another company (creating enormous amounts of "goodwill"), but when it became obvious that the acquisition wasn't paying for itself, CEOs refused to write down the worthless good will.

Now the pendulum has swung to the opposite extreme, and people are rehashing all the complaints against mark to market.

But as investors, we shouldn't get ourselves tangled up in accounting minutia. We have to look at the underlying business(es) and understand what is going on.

You have no doubt read about all the homes being foreclosed upon all over the country? The even larger number of people who are behind on mortgage payments? You must have read how home prices as a multiple of income are STILL many times higher than historical "norms". These people are not paying (and probably cannot pay).

If they cannot pay, that means the folks on the other side of the transaction-- the people who own the mortgage securities-- are not getting paid. Lehman (and the rest) paid money up front to buy the mortgages (ultimately they lent the money to the homeowners) -- and now they are not going to be paid back.

That means they have billions in losses... it doesnt matter if you look at it on a cost basis or a mark to market basis -- they have massive losses either way.

Lehman's problems are compounded because they bought those mortgages at extreme leverage. And many of the mortgages are in securitized forms that are very illiquid -- making them difficult to price even if you are a mortgage securities analyst/trader.

That is why Lehman (and many other banks) are insolvent -- whether you use cost basis or mark to market accounting.

There are hundreds of investors with a lot of cash and a lot of smart analysts working for them who would sweep in and buy Lehman on the cheap if they were truly solvent.

Debating the Lehman Collapse

Auditors also signed off on Enron's books. The only thing auditors do is spot check some (not all) assets.

Goldman and Morgan Stanley (and Lehman) have no way to properly value many of the illiquid assets on Lehman's books. The assets are listed at costs established during the real estate bubble -- way too high.

If Goldman et al are unable to value the assets -- its ridiculous to cite a bunch of CPAs rubber stamping Lehman's cost as being in any way accurate.

The firm is not solvent and there is no madness. There is nothing illogical about the price. If there was any merit to LEH, there are many smart and cash rich players who would jump in and take the free money.

Debating the Lehman Collapse

DJT -- I think we understand your point, you are missing ours.

If, as you seem to suggest, LEH's stock is "unfairly" battered down -- why wouldn't one or more of Dick Fuld's numerous friends on Wall Street start buying like crazy?

Why wouldn't Goldman (or Morgan Stanley or whomever) buy LEH stock and make a windfall once the market "comes to its senses"?

Goldman is certainly in at least as good position (arguably better) than anyone on this board to evaluate Lehman's assets/liabilities. So is Morgan Stanley. So are many others. Why doesn't Warren Buffet jump in? Heck, why doesn't some allegedly greedy hedge fund manager jump in? If Lehman stock is "unfairly" down (whether short selling or "rumors" or whatever conspiracy), why don't any of these well heeled, long term investors want to make easy money?

The obvious answer is: Lehman stock is down for very good reasons. Over-leverage, illiquid assets that are difficult to value and even more difficult to sell, and poor risk management

Lehman has had access to Fed lending programs for months (since two days after Bear's collapse) -- so its very confusing why would you suggest Paulson and Geither go *announce* something that everyone has known for months? It has already been done -- and it failed to stablize the markets.

Dick Fuld is a smart guy -- what makes you think he hasn't already shown the books to potential buyers? There have been many rumored suitors (Goldman, BankAmerica, Korean Development Bank, etc)

This isn't an unnecessary fire sale -- its the very easily anticipated result of a decision to get overlevered in illiquid assets.

You need to think ahead a few moves with your suggestion that Lehman be given a pass-- especially at taxpayer expense. How could Lehman ever hope to enforce a margin call against a customer in the future? Do what we say, not what we do?

Debating the Lehman Collapse

And none other than Warren Buffet has dismissed the naked short selling conspiracy...

jeffmatthewsisnotmakin...

Buffet is not worried about naked short selling of Berkshire Hathaway -- in fact he offers to hold a special meeting to help anyone who wants to try.

Buffet cites a windfall profit he made off short sellers in US Gypsum

Short selling is simply not an issue for a well run firm.

Debating the Lehman Collapse

The whole short sale conspiracy theory has been repeatedly discredited -- in addition to the president of Indonesia, short sale conspiracy advocates are keeping company with the CEO of overstock.com ...

The NY Times also discredited the idea that naked short sellers are somehow manipulating markets
norris.blogs.nytimes.c.../

The fact is, healthy companies don't ever seem to fall victim to these alleged conspiracies -- or more to the point, they are very transparent and conservatively leveraged, so it is very easy for a healthy company to convince the markets that the short sellers are wrong.

There is no conspiracy to drive down LEH or any other financial company. They are over-levered into too many illiquid assets. As sad as it is to see LEH go, it is dying because of its own mistakes

Debating the Lehman Collapse

"Hmm. Seems to me that buyers of firms shorted to death (Countrywide, Bear, Indymac,Leh...) won't..."

Every example you cited (except LEH, which is on going) has been found in hindsight to be insolvent. BAC has refused to guaranty the debt of Countrywide. JPM refused (even with the Fed's gun to his head) to take Bear Stearns unless the Fed took $29 billion of garbage. IndyMac is already straining FDIC.

And Goldman Sachs has said flat out they will not take LEH unless the Fed or Treasury takes some bad assets out of the mix.

So either Goldman is crazy -- or Research123 thinks he knows more than people who have actually been given detailed access to LEH's books.

Debating the Lehman Collapse

If LEH were able to make its books transparent -- which is impossible given the assets they hold -- the short sellers would be discredited in an instant. LEH's lack of transparency is the problem.

If the questionable assets were a small part of the total, and small in relation to shareholder equity -- the short sellers would have nothing to go on. LEH's excessive leverage is the problem

Short selling "abuses", if they exist, are only possible because of poor decisions made by LEH.

Crying about short sellers is the sort of thing Wall Street USED TO make fun of when the former President of Indonesia did it at the start of the Asian crisis.

No one has ever cited a single example where an otherwise solvent firm was brought down by speculators / short sellers. A strong solvent firm (or country) has numerous easy ways to fight any short selling.

Debating the Lehman Collapse

Its really embarrassing how many so-called "capitalists" want the government to step in and rescue over-levered banks with balance sheets that cannot be deciphered even by insiders.

Even though (most) people like Dick Fuld, not even his friends and supporters can figure out the value of what is on LEH's books. Its not obvious that Dick Fuld knows, given there is no market for many of these assets. LEH's supporters keep whining about an alleged capital ratio or book value -- both of which rely on questionable accounting judgments about the very assets that are causing the banks demise.

The most telling thing is to ask what would LEH do if one of its own customers got over-levered? What would LEH do if you bought something on leverage through LEH and that asset went down?

The answers are obvious: over-levered customers would be required to de-lever immediately, selling whatever assets at the current market price. If you tried to argue with your broker that XYZ stock is undervalued by the market and so the margin call is totally unfair-- your broker would just laugh at you. These responses are not unique to Lehman; the same outcome would happen at any brokerage.

You know what people think about those who cannot take their own medicine...

Distinguishing Between Out of Favor Sectors and Doomed Ones

DM: On an unrelated note, what should be the terms for bailing out Lehman Brothers?

What? Why do you assume a bailout is necessary?

Lehman's counterparties are all "institutional investors". People with MBAs and PhDs. People who collect millions of dollars per year in compensation because they are supposedly so much smarter than everyone else.

The argument to bail out Lehman (or WaMu or any other) is ridiculous. The consumer is roughly 70% of the economy -- that's more than ALL the banks put together. If XYZ bank is too big to fail, then the consumer is way way way too big to fail.

So we should all send our mortgages and credit card bills to Paulson. And under the too big to fail doctrine, we have every right to expect him to pay every single one of them. 70% of the economy is clearly too big to fail. And the majority of consumers do not have MBAs or PhDs like the "sophisticated investors" who work on Wall Street -- we are far more deserving of help. Where is our bail out?


Or, we could follow the ideas that once made America the great country it USED to be (and could be again). Let the people who made poor investments bear the consequences of their decisions.

If you traded with Lehman or WaMu or whomever -- you get the results of your decision good OR bad. If you make money, its yours. If you lose money, its also yours.

Of course, this means a lot of Wall Street will fail. But they are hardly "victims" of anything, except their own decision making.

On Recent Financial Stories

Regarding Citi (and most banks) -- its standard MO for lame CEOs and their management consultants to suggest trimming costs by slashing the IT and back office budgets. What is really surprising is that anyone outside the company would give a shred of credence to the idea.
1) It was the CEO and the "profit" centers who got over-levered on mortgage debt they didnt understand
2) It was the CEO's earlier decisions to ignore risk management and not develop proper risk management software... its far from obvious how cutting these areas further will do anything but hurt
3) Exactly how many traders does it take to go out and buy assets they clearly don't understand and on absurd leverage? Any janitor who dropped out of high school could lose billions just as fast -- and a lot cheaper
4) Does Citi need thousands of securitization lawyers and deal makers considering the market is all but shut down? Do any of the banks need this?
5) Why is management overly concerned with approving first class business airline tickets? If there was actual business activity occurring, a multi-billion dollar corporation really shouldn't care between $300 and $3000... the real question is "Why are you flying at all?" Since there is no business going on, don't fly at all. Get rid of the managers who want to fly first class -- and while you are at it, get rid of the manager who does the approving.
6) This one is a no brainer: save millions by getting rid of all the McKinsey people or else all the Citi managers. If the Citi managers don't know what they are doing, why are they there? If they do know what they are doing, why is McKinsey there? Two completely redundant management structures

But even with two redundant management structures, the best plan they can come up with is to make cuts in risk management and IT? How many McKinsey people did it take to conclude that firing people who had nothing to do with the mistakes that caused the bank's collapse won't result in lower staff morale?

The Credit Bubble: Deregulation Gone Wild

Deregulation is the big lie here. Government is MUCH bigger now than when Reagan took office. The Fed knew perfectly well what was happening, and on several occasions issued warnings. They had, and still have, the authority to regulate lending practices at the money center banks (and the little banks tend to follow). The other lending is done by FNMA and FHLMC, which are completely government controlled.

Before you start expanding regulatory power, you need to ask why the regulators made almost no use of their existing powers. You need to establish that existing powers are insufficient -- as opposed to just unused.

Even if you make the Fed into an absolute dictator, what good would it do if they don't use their powers (for good)?

The problem isn't deregulation (which never happened except on paper). The problem is the regulations we already have were not enforced.

The government had to choose between collecting higher taxes on bubble homes, or enforcing the existing rules. The government repeatedly chose higher taxes by turning a blind eye to a problem they knew about all to well.