Remember on Seinfeld when Kramer was so excited that he exclaimed, “Giddy Up”? Well markets decided to saddle up yesterday and see what it’s like to trade higher—certainly a novel idea as “the most significant financial crisis since the Great Depression” continues to unfold (Note to the networks—love the new graphics!)
After being down 150 points at 1:00 pm or so, stocks meandered to the unchanged line. Then at approximately 3:00 pm, something happened…all of the sudden, buyers piled into equities, as reports emerged that the federal government was about to take steps to create the mother of all bailouts. While there were few details available, the simple notion that the government was going to do something BIG, allowed investors to breathe a sigh of relief. The surge was lead by financial companies as the Dow Jones Industrial Average swung in a 567-point range from the low of the day to the close, ending 410.03 points higher, up 3.9%, at 11019.69. The S&P 500 Index climbed 4.3%, its biggest daily percentage gain in nearly six years, to end at 1206.33 and the Nasdaq Composite Index leapt 4.8%, its biggest daily move in more than five years, to end at 2199.10 as big technology companies posted solid gains. Gold had closed before the bailout news hit, so it is likely that yesterday’s nearly $50 move up will be erased today.
Markets had been trading higher earlier in the day on Thursday after the Fed authorized a $180 billion expansion of its swap lines with other world central banks. But soon that was not enough, so Henry Paulson and Ben Bernanke, (the President and Vice President of our economy), determined that something bigger was necessary. The plan is to create some sort of government agency that would purchase distressed mortgages at deep discounts from banks and other financial institutions. This is something along the lines of the Resolution Trust Corp. (RTC), which was a key tool to liquidating holdings of failed savings and loans in the late 1980s and early 1990s. Created in 1989, the RTC disposed of bad assets held by hundreds of crippled savings and loans that had been burned in the eighties real estate boom. The RTC closed or reorganized 747 institutions holding assets of nearly $400 billion. By 1995, the S&L crisis had passed and the RTC was folded into the FDIC. The difference is that the 2008 version of the RTC would have the government taking over the distressed assets, not the entire institutions.
Beyond the RTC-like plan, before the opening bell today, the government unveiled a plan to shore up money-market funds, which experienced massive redemptions as one fund “broke the buck” and fear intensified earlier this week. There is likely to be some sort of federal insurance for investors in money market funds (which total $3.4 trillion), akin to the coverage offered by the FDIC for bank accounts. Finally, the SEC (remember them?) is reinstating the temporary ban on short-selling of hundreds of financial stocks. The move comes a day after the UK’s Financial Services Authority (FSA) announced that it was banning short selling on financial stocks until the end of the year. Put all of this together and it looks like another up day for stocks…giddy up!
Friday, September 19, 2008
Thursday, September 18, 2008
Blood in the Streets
Baron Rothschild, the quintessential banking opportunist, is said to have advised that the best time to buy is when there is "blood in the streets." To some, the first three days of this week indeed feels like blood is spilling on capitalism’s most famous avenue, that is, Wall Street. Yesterday felt like a replay of Monday, only without a big deal or a government loan announced.
Despite Treasury Secretary Paulson’s efforts to stave off a financial panic with an $85 billion rescue of AIG, stocks resumed their descent. The pain was spread across the board, with few places to hide for stock investors. The Dow ended near a three-year low, down 449.36 points, or 4.1%, at 10609.36, off 7.1% so far this week; the S&P 500 dropped 4.7% to 1156.39, down 7.6% for the week; the Nasdaq was down 4.9% at 2098.85, down 7.2% for the week; and the small-stock Russell 2000 fell 4.8% to 676.38.
The catalyst for the selling was fear, plain and simple. It started on Tuesday night, when the cost for borrowing skyrocketed, which put more pressure on investment banks, which need short-term funds to operate. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, led the selling spree. Specifically, unsubstantiated rumors were swirling around Morgan as speculation mounted that it would be the “next Lehman”. Both firms reported earnings that were in the black, and Morgan’s beat estimates handily, but that did not assuage nervous investors, who drove down MS shares by 24% and Goldman’s by 14% yesterday.
Both firms railed against short-sellers and the SEC finally listened and announced three actions addressing shorting. First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three-day delivery requirement and finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. Unfortunately, these measures come a little too late. As written in this column this year, the SEC should never have eliminated the Uptick Rule (which they did in the midst of a bull market!) and appears to be asleep at the switch when it comes to eliminating abusive short selling and rampant rumor mongering.
With that rant out of the way, what about that Baron Rothschild? Those investors who embrace his advice might be strong enough to turn a blind eye to the fear and panic gripping the markets and start dipping their toes in the murky investment waters. If you have a long time horizon, this could be a time to increase your retirement plan contributions or add a little extra each month to your investment account. Yes, it is difficult to do, but years from now, you just might look back and thank Baron Rothschild for turning you a bit more bullish at a time of maximum pessimism.
Despite Treasury Secretary Paulson’s efforts to stave off a financial panic with an $85 billion rescue of AIG, stocks resumed their descent. The pain was spread across the board, with few places to hide for stock investors. The Dow ended near a three-year low, down 449.36 points, or 4.1%, at 10609.36, off 7.1% so far this week; the S&P 500 dropped 4.7% to 1156.39, down 7.6% for the week; the Nasdaq was down 4.9% at 2098.85, down 7.2% for the week; and the small-stock Russell 2000 fell 4.8% to 676.38.
The catalyst for the selling was fear, plain and simple. It started on Tuesday night, when the cost for borrowing skyrocketed, which put more pressure on investment banks, which need short-term funds to operate. The two remaining independent investment banks, Goldman Sachs and Morgan Stanley, led the selling spree. Specifically, unsubstantiated rumors were swirling around Morgan as speculation mounted that it would be the “next Lehman”. Both firms reported earnings that were in the black, and Morgan’s beat estimates handily, but that did not assuage nervous investors, who drove down MS shares by 24% and Goldman’s by 14% yesterday.
Both firms railed against short-sellers and the SEC finally listened and announced three actions addressing shorting. First, the SEC adopted a rule requiring short sellers and their broker-dealers to deliver securities by the settlement date (three days after the transaction date) and imposing penalties for failure to do so. In addition, the SEC eliminated the option market-maker exception to the three-day delivery requirement and finally, the SEC adopted a new anti-fraud provision making it unlawful for sellers to deceive specified persons about their ability or intention to deliver securities by the settlement date. Unfortunately, these measures come a little too late. As written in this column this year, the SEC should never have eliminated the Uptick Rule (which they did in the midst of a bull market!) and appears to be asleep at the switch when it comes to eliminating abusive short selling and rampant rumor mongering.
With that rant out of the way, what about that Baron Rothschild? Those investors who embrace his advice might be strong enough to turn a blind eye to the fear and panic gripping the markets and start dipping their toes in the murky investment waters. If you have a long time horizon, this could be a time to increase your retirement plan contributions or add a little extra each month to your investment account. Yes, it is difficult to do, but years from now, you just might look back and thank Baron Rothschild for turning you a bit more bullish at a time of maximum pessimism.
Wednesday, September 17, 2008
AI-G-WHIZ
It seems that I can no longer prepare my articles until the wee hours of the morning. Yesterday morning, I was planning to write about the details of the Fed meeting (they left rates unchanged at 2%). By the afternoon, I was conducting research on bankruptcy of insurance companies (great information at www.nolhga.com). Late last night after learning that the government provided AIG with an $85 billion bridge loan to prevent the mammoth company’s failure, I figured the writing would have to wait.
At 6:00 am on Wednesday morning, here is what we know. After a weekend when government officials allowed Lehman Brothers to fail, the Federal Reserve reversed course and determined that mega-insurer AIG had far too many tentacles across the financial system and could not allow the company to fail. The underlying problem is that AIG played a big role in underwriting insurance contracts on esoteric debt instruments that were originally connected to the housing market.
As a reminder, banks wrote mortgages and sold them to investment banks, like Lehman Brothers or Merrill Lynch. The investment banks then packaged the mortgages into securities and sold them to (mostly) institutional investors. To protect investors against defaults, AIG sold insurance on those securities (credit default swaps). These unregulated insurance contracts required AIG to cover losses suffered by buyers in the event the securities defaulted, putting AIG on the hook for losses associated with billions of dollars of risky securities that were once viewed as safe.
AIG posted collateral to guarantee that it could repay investors if needed. The contracts specified that if AIG’s credit ratings were cut, it was required to post more collateral. Credit agencies cut AIG’s ratings on Monday, pushing AIG to the brink of bankruptcy. Here is the problem: if AIG would have failed, it would have set off a dangerous chain reaction where institutional investors would have then been forced to sell the bad stuff, driving prices even lower. AIG was simply too connected to various key markets, including: credit derivatives, mortgages, corporate loans and hedge funds. Additionally, there is a vast consumer component to the AIG story because the failure of AIG would affect millions of insurance policyholders, retirement plan participants and investors with money market funds with AIG. Simply put: AIG was just too interconnected to fail.
The world’s financial system could not easily absorb an AIG bankruptcy so the Fed acted. (It would have been nice if the ECB stepped up, considering that at midyear, ¾ of AIG’s credit default swaps were held by European banks, but that is another column.) Under the plan, the Federal Reserve will extend a two-year loan to AIG, of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80% ownership of the insurer, if the existing shareholders approve. Finally, AIG will continue to operate during this period so if you own an AIG product, try not to drive yourself crazy. In essence, the government has provided you with a big safety net and hopefully, a better night’s sleep.
At 6:00 am on Wednesday morning, here is what we know. After a weekend when government officials allowed Lehman Brothers to fail, the Federal Reserve reversed course and determined that mega-insurer AIG had far too many tentacles across the financial system and could not allow the company to fail. The underlying problem is that AIG played a big role in underwriting insurance contracts on esoteric debt instruments that were originally connected to the housing market.
As a reminder, banks wrote mortgages and sold them to investment banks, like Lehman Brothers or Merrill Lynch. The investment banks then packaged the mortgages into securities and sold them to (mostly) institutional investors. To protect investors against defaults, AIG sold insurance on those securities (credit default swaps). These unregulated insurance contracts required AIG to cover losses suffered by buyers in the event the securities defaulted, putting AIG on the hook for losses associated with billions of dollars of risky securities that were once viewed as safe.
AIG posted collateral to guarantee that it could repay investors if needed. The contracts specified that if AIG’s credit ratings were cut, it was required to post more collateral. Credit agencies cut AIG’s ratings on Monday, pushing AIG to the brink of bankruptcy. Here is the problem: if AIG would have failed, it would have set off a dangerous chain reaction where institutional investors would have then been forced to sell the bad stuff, driving prices even lower. AIG was simply too connected to various key markets, including: credit derivatives, mortgages, corporate loans and hedge funds. Additionally, there is a vast consumer component to the AIG story because the failure of AIG would affect millions of insurance policyholders, retirement plan participants and investors with money market funds with AIG. Simply put: AIG was just too interconnected to fail.
The world’s financial system could not easily absorb an AIG bankruptcy so the Fed acted. (It would have been nice if the ECB stepped up, considering that at midyear, ¾ of AIG’s credit default swaps were held by European banks, but that is another column.) Under the plan, the Federal Reserve will extend a two-year loan to AIG, of up to $85 billion and, in return, will receive warrants that can be converted into common stock giving the government nearly 80% ownership of the insurer, if the existing shareholders approve. Finally, AIG will continue to operate during this period so if you own an AIG product, try not to drive yourself crazy. In essence, the government has provided you with a big safety net and hopefully, a better night’s sleep.
Tuesday, September 16, 2008
The Ides of September
Yesterday was a rough day. I know because for the first time this year, I heard panic in some voices. I am not talking about clients, but sophisticated investment professionals who sounded like rank amateurs. This is not to dismiss the magnitude of what has occurred this year or even over the weekend, but typical of Wall Street, the focus was so misplaced that it made me nuts. Let’s start with some important points.
1) What does this mean to the average investor? Many investors are wondering whether they should pull out of their investment accounts and wait until the storm passes. The answer for most of them is NO. This is one of the most difficult concepts to grasp, but assuming that you are a long-term investor and do not need to access your money for 5-10 years, you should guard against the emotional pull of the mattress. Going through bear markets is the price you pay for being a long-term investor. If you pull out, you risk not participating in the recovery and although the current situation is difficult, it is good to remember that the economy and markets move in cycles—for every “down” cycle, there has been a subsequent “up” cycle. In fact, the most dangerous part of going to cash is that rarely do investors have the wherewithal to get back in. As an example, if you bailed out in October 2002, you probably missed 2003-2007, when stocks returned 12.8% annually. If you are using a retirement plan, you are buying stocks at a 20% discount to where they were almost a year ago.
2) Yesterday I discussed Securities Investor Protection Corporation (SIPC), but today I want to speak to those folks who have accounts at Merrill Lynch. The purchase of Merrill by Bank of America should not affect you financially. There is likely to be a re-branding of ML into “Merrill Lynch Wealth Management” and down the line, Merrill customers may actually have increased access to BOA banking functions. If your ML broker is smart, he or she will stay put, because there are not too many jobs on Wall Street right now!
3) Will this affect the broader economy? Until this point, the non-financial part of the US economy has been pretty resilient. The pullback in energy prices should continue to help and the nationalization of Fannie and Freddie have already helped mortgage rates drop, which in turn should help stabilize housing. While nobody knows what the future will bring, I am hopeful that this dramatic weekend will come to symbolize the point of maximum fear. After which we can repair the frayed nerves of investors and the economy as a whole.
Finally, a note to my friends on Wall Street: as usual, you believe that the world revolves around you. There is more to the US economy than the financial sector and although I am sorry to see anyone lose a job, why is a job at Lehman Brothers more precious than one at Ford or GM? It’s time to recognize that when you party too hard, the hangover is going to be substantial. Get out your Tylenol and prepare for a serious headache.
1) What does this mean to the average investor? Many investors are wondering whether they should pull out of their investment accounts and wait until the storm passes. The answer for most of them is NO. This is one of the most difficult concepts to grasp, but assuming that you are a long-term investor and do not need to access your money for 5-10 years, you should guard against the emotional pull of the mattress. Going through bear markets is the price you pay for being a long-term investor. If you pull out, you risk not participating in the recovery and although the current situation is difficult, it is good to remember that the economy and markets move in cycles—for every “down” cycle, there has been a subsequent “up” cycle. In fact, the most dangerous part of going to cash is that rarely do investors have the wherewithal to get back in. As an example, if you bailed out in October 2002, you probably missed 2003-2007, when stocks returned 12.8% annually. If you are using a retirement plan, you are buying stocks at a 20% discount to where they were almost a year ago.
2) Yesterday I discussed Securities Investor Protection Corporation (SIPC), but today I want to speak to those folks who have accounts at Merrill Lynch. The purchase of Merrill by Bank of America should not affect you financially. There is likely to be a re-branding of ML into “Merrill Lynch Wealth Management” and down the line, Merrill customers may actually have increased access to BOA banking functions. If your ML broker is smart, he or she will stay put, because there are not too many jobs on Wall Street right now!
3) Will this affect the broader economy? Until this point, the non-financial part of the US economy has been pretty resilient. The pullback in energy prices should continue to help and the nationalization of Fannie and Freddie have already helped mortgage rates drop, which in turn should help stabilize housing. While nobody knows what the future will bring, I am hopeful that this dramatic weekend will come to symbolize the point of maximum fear. After which we can repair the frayed nerves of investors and the economy as a whole.
Finally, a note to my friends on Wall Street: as usual, you believe that the world revolves around you. There is more to the US economy than the financial sector and although I am sorry to see anyone lose a job, why is a job at Lehman Brothers more precious than one at Ford or GM? It’s time to recognize that when you party too hard, the hangover is going to be substantial. Get out your Tylenol and prepare for a serious headache.
Monday, September 15, 2008
Sunday Headlines
I waited all weekend to write this article. I thought that I might report about a complicated transaction, where Lehman Brothers would be split into a “good bank-bad bank” structure. I would be able to discuss how interesting it was that Barclays, a UK institution ended up with the good stuff, while all of the large US players ended up with the crud. At 7:30 pm, there is no deal to save Lehman Brothers, but there is another mega-merger on the table as well as a potential shake up at a large insurer.
Starting with the 158-year-old Lehman, we went from too many suitors to too few. BOA and JC Flowers/CITIC bowed out, leaving Barclays as the sole contender on Sunday morning. But according to the Wall Street Journal, Barclays stepped aside when it became clear that the government was not willing to be involved in a transaction. This left a dark path for Lehman—an “orderly” liquidation, managed by the law firm Weil, Gotshal & Manges LLP, which was engaged to prepare a potential bankruptcy filing.
According to the WSJ, “if Lehman files, the firm's brokerage units would have to enter a Chapter 7 liquidation, in which a court-appointed trustee would take over, liquidate the firm's assets and get Lehman customers back their money. In general, securities that a customer holds at a brokerage firm are legally the investor's property and aren't exposed to the claims of the firm's creditors.” If you are a customer of Lehman, it is likely you will start to hear about Securities Investor Protection Corporation (SIPC). If sufficient funds are not available in the firm’s customer accounts to satisfy claims within specific limits, the reserve funds of SIPC are used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $100,000 for cash claims. Additional funds may be available to satisfy the remainder of customer claims after the cost of liquidating the brokerage firm is taken into account.
A funny thing happened on the way to Lehman’s demise…two other firms started courting one another. I found out about this while at a wedding shower—a friend checked his Blackberry at 4pm and announced, “The wedding of Barclays and Lehman is off, but there could be one for Bank of America and Merrill Lynch!” WHAT? After looking hard at Lehman, BOA brass thought that a better match might be found in Merrill. The information was sketchy and maybe the whole deal will fall apart, but according to a variety of sources, Merrill's board was reportedly meeting to approve an offer at $29 a share, which would value the firm above $40 billion, a nice premium to Friday’s close of $17.
Finally, another financial company made the Sunday headlines glow. Again, according to the WSJ, AIG plans to disclose a comprehensive restructuring today that is “likely to include the disposal of major assets including its aircraft-leasing business and other holdings, according to people familiar with the matter…the moves follow a 31% drop in AIG's stock price on Friday amid concern that its capital base isn't sufficient to cover its obligations.” Boy, who ever said that Sunday was a day of rest? Stay tuned!
Starting with the 158-year-old Lehman, we went from too many suitors to too few. BOA and JC Flowers/CITIC bowed out, leaving Barclays as the sole contender on Sunday morning. But according to the Wall Street Journal, Barclays stepped aside when it became clear that the government was not willing to be involved in a transaction. This left a dark path for Lehman—an “orderly” liquidation, managed by the law firm Weil, Gotshal & Manges LLP, which was engaged to prepare a potential bankruptcy filing.
According to the WSJ, “if Lehman files, the firm's brokerage units would have to enter a Chapter 7 liquidation, in which a court-appointed trustee would take over, liquidate the firm's assets and get Lehman customers back their money. In general, securities that a customer holds at a brokerage firm are legally the investor's property and aren't exposed to the claims of the firm's creditors.” If you are a customer of Lehman, it is likely you will start to hear about Securities Investor Protection Corporation (SIPC). If sufficient funds are not available in the firm’s customer accounts to satisfy claims within specific limits, the reserve funds of SIPC are used to supplement the distribution, up to a ceiling of $500,000 per customer, including a maximum of $100,000 for cash claims. Additional funds may be available to satisfy the remainder of customer claims after the cost of liquidating the brokerage firm is taken into account.
A funny thing happened on the way to Lehman’s demise…two other firms started courting one another. I found out about this while at a wedding shower—a friend checked his Blackberry at 4pm and announced, “The wedding of Barclays and Lehman is off, but there could be one for Bank of America and Merrill Lynch!” WHAT? After looking hard at Lehman, BOA brass thought that a better match might be found in Merrill. The information was sketchy and maybe the whole deal will fall apart, but according to a variety of sources, Merrill's board was reportedly meeting to approve an offer at $29 a share, which would value the firm above $40 billion, a nice premium to Friday’s close of $17.
Finally, another financial company made the Sunday headlines glow. Again, according to the WSJ, AIG plans to disclose a comprehensive restructuring today that is “likely to include the disposal of major assets including its aircraft-leasing business and other holdings, according to people familiar with the matter…the moves follow a 31% drop in AIG's stock price on Friday amid concern that its capital base isn't sufficient to cover its obligations.” Boy, who ever said that Sunday was a day of rest? Stay tuned!
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