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Monday, September 15, 2008

Monday Bloody Monday

That's the only way to describe the economic hurricane to hit Wall Street this morning. Lehman Brothers is filing for Chapter 11. Merrill Lynch is being bought out by Bank of America for half what it was worth a year ago. Finally, AIG is on the bring of destruction and looking for financing.

First, this latest hurricane of bad news on Wall Street should indict the current Federal Reserve policy. I was weary of the Fed's aggressive action in saving Bear Stearns from financial disaster. At the time, the Fed not only acted as the Federal Reserve and opened up its coffers to back the deal. The Fed also acted as an investment banker and a rainmaker. It brought Bear Stearns and JP Morgan together. It negotiated the deal, and it even extended a line to make sure the deal went through. Most troubling of all, the Fed forced this deal on both sides over a weekend when it would normally take many months to negotiate something like this. This was all done under the assumption that 1) Bear Stearns' failure would be too much of a shock to the markets to allow and 2) this would not become something the Fed would do regularly.

These assumptions only worked if Bear Stearns was a unique situation. Clearly that was a faulty assumption. Here is how my colleague Francis Cianfrocca at Redstate described it.

As I described here, this is the weekend that the Treasury and the Federal Reserve decided to stop bailing everyone out. Secretary Paulson has been hinting for weeks now that we have to let capitalism work the way God intended it to. Which means: if you screw up, you die.

This is what we free-market conservatives have been saying we wanted all along, folks. We'll be getting a chance to eat our own dog food. On balance, I have to say it's a good thing... I hope.We are now going to see the unwinding of the 158-year-old broker-dealer Lehman Brothers.

The regulators are going to try this another way, and they decided to let Lehman die without the benefit of an overt and specific public bailout, as had been the case with Bear Stearns and Fannie Mae/Freddie Mac.

Unfortunately, responding to financial crisis is not the sort of thing we can try through trial and error. I am not privvy to private correspondence but I'd be willing to bet the powers that be at Lehman saw what the Feds did for Bear Stearns and expected the same for them. Now then, the time for serious criticism is later. More important for now is what the immediate future holds. Francis picks that up.

The Federal Reserve did announce last night that its various emergency-liquidity facilities would be significantly broadened and expanded in scope. If you're so inclined (and I am), you can consider this another kind of bailout. But the Treasury and the Fed both refused to give Wall Street what the latter were looking for, which is an explicit public guarantee of Lehman's distressed assets. It's a completely new chapter in the Panic of 2007. (And 2008. And 200...)

Whether Lehman's assets and trading positions are liquidated in an orderly or disorderly fashion will determine the tone of the next few weeks in financial markets.

The only bright side here might be that Bank of America is acting like the vulture we need in order to facillitate a recovery. After sweeping in to buy out Countrywide, they are now eating up the remains of Merrill Lynch, though of course, that was a terribly corrupt deal. (the Countrywide buyout that is) While all of this is going on, some so called experts are adding fuel to the fire (H/T to Hot Air)

Christopher Whalen, managing director of Institutional Risk Analytics, a research firm, predicts that approximately 110 banks with $850 billion in assets could close by next July. That's out of 8,400 federally insured institutions, he said, which together hold $13 trillion in assets. Individual customers are starting to get nervous about the financial health of their banks for the first time in generations, he said. Whalen's firm analyzes the safety and soundness of banks for business clients, but began receiving inquiries from individuals in the past two months for the first time, he said.

"If we don't get ahead of this, we are going to face a run on the retail banks by election day," he said.

AP Business Writers Madlen Read, Tim Paradis and Stephen Bernard in New York, Martin Crutsinger in Washington, Ieva Augstums in Charlotte and Michael Liedtke in San Francisco contributed to this report.

Now, before anyone runs out and withdraws all their cash, just keep in mind most accounts are insured up to 100k. This sort of nebulous and cryptic fear mongering is the worst kind of thing at a time like this. Without offering anything concrete, this analyst says that "some customers are getting nervous" and if we don't get out "front there will be a run on banks". That is the sort of irresponsible statement that sets off a panic where there wasn't one.

I, for one, think this may wind up being a good thing in the end. Think about what is happening now as some sort of cleansing. It's like the financial equivalent of one of those teas you can buy at GNC that cleanses the body of all of its toxins. The financial market has lots of toxins in the form of bad loans. Now, all the banks and other financial institutions that hold onto these need to be removed and only leave those that didn't get too weighted in said loans. That's what is happening today. Keep in mind that these teas make you need to go to the washroom over and over when you take one, but you wind up feeling better days and weeks later. The same thing can happen now if we all let the market do what it does, and no one panics.


Anonymous said...

the FDIC is has enough money to cover $50 billion. unfortunately, fdic backed banks total $1 trillion in deposits.

mike volpe said...

Slow down tiger. No one is claiming yet, that each and every bank is about to fold. Of course, if enough fear mongers get their way, then we will cause a run on banks.

Anonymous said...

Oh stop. 1989 was Black Monday This isn't anywhere near that drop percentage-wise. This is more fallout from the mortgage mess and there are only a couple more humps to get over, which won't be as dramatic as Lehman. The Fed will probably lower the interest rate another 1/2 point to help out. In my opinion, the trillions sitting in money market funds will eventually flood back into the market. Do you believe in the strength of the economy? I do, so I am going to grab the bargains now. Bank preferred stocks are selling at a discount and yielding pretty high rates (8% or more). Beats a MM. The big banks aren't going anywhere and will get bigger as they buy up assets of smaller banks and brokerages. Because if they fail too....then your money won't be worth anything anymore anyway.

But don't take my opinion as investment advice.

mike volpe said...

I am being Provocative, as the title of the blog. Of course, we have seen worse, much worse, but the title is a play on the U2 song. It is still not a good day in the market and I wrote it at the beginning of the day. My analysis had nothing to do with the drop in stock prices. This is merely about three major financial institutions in turmoil.