Wednesday, March 19, 2008
I think I am turning Japanese.
While I am skiing with my family in the canyons, I have followed with morbid interest the demise of Bear Stern.
From $17B in cash to bankrupt in 3 days. The price paid of $2 per share, down from 70, is merely symbolic, reflecting the "$2 dollar broker" pejorative moniker used on Wall Street to describe the "lowest of the low" in the banking cast. What it really says is that Bear was completely insolvent.
Lehman and Goldman post good numbers but the combined exposure of the banks is still unknown and the combined equity of the top 5 is $150B. It is puny compared to the $500B loss to be reckoned with in the market. A 30% share of the exposure would wipe them out. The orders of magnitude are in the same league.
Contemplating the insolvency of the banking system, as hinted by the sudden Bear demise, even if temporary and forced by mark to market accounting, is a scary proposition and I read this morning that the banks are shunning the discount window where they could get temporary liquidity for fear of rumors about their insolvency and suffering the same fate. Hmm cuts both ways, as I read this as denial and tacit acknowledgment that the insolvency is here.
Meanwhile the FED is throwing meat to the bears to appease them. In a highly original move they have opened the windows to a wider audience. This way banks can post collateral from their clients (hedgies etc) and this is the FED way of extending liquidity to those fringes of the financial system. The markets have responded well to the moves.
The award for "the dummest professional blog I have read this week" has got to go to "MarketWatch" where some 2 dime analyst writes that "the market has given us a double 9 to 1 signal" which on the surface of it sounds deep but in reality refers to "2 days of trading where 9 stocks go up for each 1 that goes down" which historically is a signal of a STRONG bull market. What the article forgets to correlate is that the FED have taken dramatic action on both days and this is purely FED driven not "standalone market action".
A better analysis I have read by Roubini at RGE made the point that monetary easing and the FED action lately helped the speculators more than it helped address the underlying problem, namely the potential insolvency of our banking system due to the subprime and credit crisis. I still believe that when the main facilities go on on March 27, there could be easing.
Roubini, a bear amongst bears, is now talking about the "bank run on the shadow financial system" a step in his prescient and now infamous "12 steps to the mother of all meltdowns". Again the hedgies are being clobbered by the banks and their own investors who are rushing to get their equity or debt out of the frail vehicles. Train spotting may become my favorite pass-time.
But really I am waiting for one more shoe to fall. The main trigger was El-Erian of PIMCO publicly calling for the FED to buy stricken securities to prop up the markets and asset values. Here is a gentleman that was successful in investing while at Harvard and is now calling for bail-out of the financial industry at large, by putting a floor on the losses, at the expense of tax-payers and at the benefit... of guys like him. Yikes! Is it that bad? Also moral hazard? what moral hazard?
A great article was written recently on Bloomberg explaining why "mark to market" was not the culprit. Basically the argument goes that 1/ FAS157, does not require you to mark to market, only to disclose what you marked to market and market to model, but you can choose apparently. 2/ accounting is not responsible for the losses in the first place (subprime) it just accounts for it.
Argument 2/ is debatable, while it is true that the losses are real, they are still unrealized and unknown, those who do mark to market may be putting more strain on the system by triggering systemic constraints and forcing margin calls on hedgies for example, which in turn dump at fire-sale prices all of it fueling the "run on the shadow financial system" and the real system. On the other hand, not accounting for losses and staying is lala-land just delays the day of reckoning and financial history seems to indicate that the quicker you deal with the problem, the better it is, if you don't die in the process.
But really, the lost decade of Japan looms large at the moment. 10 years of stagnation and deflation triggered by a banking collapse following losses in housing and credit... the main problem was the inability of the society to deal with losses or losing face. A similar aversion to "failure/loser" is palpable at the moment and kind of pathetic. The calls by Pimco, the FAS157 criticism feel like a desperate aversion of losses.
It is one thing for the FED to stop-gap a spiraling crashing system, it is quite another to set the floor. If humpty dumpty is falling from his fence, the FED is just putting steps under it so that it orderly falls to the floor, gently stumbling from step to step rather that crashing all at once. But humpty will get to the floor and the quickly he gets on the floor, the better.
A commentator (fintag) points out that with the FED cut to 2.5, the USD is starting to look like a cary-trade currency just like the yen is, he/she says that at 1% the USA will officially be the new Japan. I prefer comparisons to Japan as opposed to drawing parallels to Banana Republics as the FT did yesterday. More dignified this way.
And with that I am going back to the slopes. Today is a beautiful day, the markets may be convulsing but the snow is sweet and the weather nice. See ya.