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Markets In Crisis: Is The End or Is The Beginning Of the End?

Monday, September 15, 2008

So the markets plunged pretty badly yesterday.

CNN had it as
Stocks get pummeled


  • "It was an ugly day," said James King, president and chief investment officer at National Penn Investors Trust Company. "Lehman's failure to find a suitor and Merrill deciding to cash in their chips before a similar fate could befall them really stoked the fears of the public."

    AIG exacerbated those fears in the afternoon. And all the bad news isn't out there yet, King said. "Investor confidence is at the lowest point we've seen in a while."
The Wall Straits Journal explained what has happened. Lehman Files for Bankruptcy, Merrill Sold, AIG Seeks Cash


  • The U.S. government, which bailed out Fannie Mae and Freddie Mac a week ago and orchestrated the sale of Bear Stearns Cos. to J.P. Morgan Chase & Co. in March, played much tougher with Lehman. It refused to provide a financial backstop to potential buyers. Without such support, Barclays PLC and Bank of America, the two most interested buyers, walked away. Barclays said Monday it pulled out of the potential deal after deciding it wasn't in the best interest of shareholders.

    Early Monday morning, Lehman filed for protection under Chapter 11 of the U.S. Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. Lehman said none of the broker-dealer subsidiaries or other subsidiaries of LBHI will be included in the Chapter 11 filing and all of the broker-dealers will continue to operate. Customers of Lehman Brothers, including customers of its wholly owned subsidiary, Neuberger Berman Holdings LLC, may continue to trade or take other actions with respect to their accounts, Lehman said.

Of course the Feds did try to calm the markets down. Fed adds most cash since Sept. 2001 to calm markets

  • The New York Fed added $70 billion in overnight repurchase agreements, known as repos. The central bank does a repo operation on almost every business day, but offered an unusually high amount today in light of the demand for reserves from banks and primary dealers.
  • The Fed adds reserves to the system in order to keep overnight lending rates near its target, currently 2%. The actual rate at which banks were trading fed funds Monday rose to at least 7% at one point, the widest spread over the target rate in at least 20 years, according to Tony Crescenzi, chief bond strategist at Miller Tabak & Co.

    The actual rate declined to 4% after the Fed's second reserve operation of $50 billion, the largest since seven years ago, when the central bank was trying to ensure markets could re-open for business.

    The rate being so much above the Fed's target "shows that demand for excess reserves is extraordinary," said Ray Stone, chief economist and co-founder of Stone & McCarthy Research.

    Money markets have effectively frozen up today because managers don't want to expose themselves to dealers in light of Lehman's bankruptcy, he said. So they're turning to banks to invest their short-term funds, but everyone offering overnight funds is demanding a higher rate to lend it.
    "I've been through many financial crises and this is all new to me," said Stone, who worked at the Fed in the 1970s.
  • Interest-rate futures jumped as traders see a 69% chance the Federal Reserve will reduce its benchmark rate at its meeting Tuesday to 1.75% from 2.00% to make borrowing and lending more feasible for a battered financial system.

    "We believe that the gravity of the situation requires a Fed ease of 50 basis points and a removal of the current 25 basis point premium of the discount rate" at which banks can borrow from the Fed directly, said T.J. Marta, income strategist at RBC Capital Markets. "Such a move would put the Fed 'ahead' of the market."

    Futures show a better chance, 84%, of that quarter percentage point cut taking place at the Fed's meeting Oct. 31.

FT.Com was more direct by calling it as World’s biggest banks join forces.

And FinancialSense market commentator was simply amazed and describes it as Disconnection: The US Financial System Morphs Into Wonderland in his market wrap editorial today.

Here's part of his long write. (ps. I had described the dollar as flying without wings on a chatbox. - Mr. Allison calls it as without fundamental legs to stand on. :D )

  • The dollar, without fundamental legs to stand on, has vaulted higher in near vertical fashion, wreaking havoc on all commodity-based assets around the world. The Fed has been forced to lend out nearly 60% of its balance sheet to keep the banks solvent. The US trade deficit is on track to be over $800 billion this year and the budget deficit could soar to $500 billion, counting small off-budget items such as the Iraq War. The credit crisis is exploding on Wall Street, while Main Street deals with a deepening recession. However in Wonderland, the dollar presses ever higher.

    Precious metals conundrum

    Physical gold and silver have grown scarce among dealers around the globe. Delivery delays and high premiums are common, from New York to London, from Dubai to Mumbai. According to Swiss bank UBS, the world’s largest gold bullion trader, “Physical demand continues at a record pace.” At the very same time, the paper prices of gold and silver have plunged, along with the stocks of the entire gold and silver mining industry. UBS notes that “huge liquidation of long positions on the Comex and OTC markets have been the major reason for the fall in gold prices.” Customers world-wide are paying large premiums for an asset that has been plunging in price. Extremely curious.

    Hurricanes in the Gulf no problem for oil prices?

    Last Friday, Hurricane Ike barreled into the Gulf of Mexico, a massive storm 600 miles across and headed for offshore oil rigs and large refineries along the Texas coast. During the day the price of oil drifted lower, ending at just over $100 per barrel. According to Reuters, fifteen U.S. oil refineries with a total capacity of 3.861 million barrels per day are now shut down in the aftermath of Hurricane Ike, the U.S. Department of Energy said on Sunday. In addition, 30 major natural gas processing plants with a total capacity of 14.55 billion cubic feet per day are closed in the Gulf of Mexico, including plants still impacted by Hurricane Gustav.

    Many rigs will need weeks, in some cases months, to get back to full production.
    On Monday, oil continued to drop after refineries escaped with less damage than expected, ending the day around $94.00 a barrel. If heavy damage was expected on Friday, why did the price of oil not launch higher in Friday trading?

    Perception becomes reality

    Senior Energy Analyst Charles Maxwell at Weeden & Co was recently quoted in Barron’s. Maxwell, 76 years old, was asked about the expectation that oil was heading for $75 a barrel. “It is the perception that really is changing, not the true value of oil throughout the system. The perception change involves whether we are going to move into an era where oil supplies will be generous and easy to find, and therefore relatively cheap - or whether those supplies are going to be closed off for both political and geological reasons.” Maxwell, a veteran analyst since the 1960’s, thinks oil is heading for $300 a barrel. For the short term, perception becomes reality.

    "In these most troubling of times, oil does not appear to make the cut as a safe enough haven," said John Kilduff, an analyst at MF Global, in a research note.
    So the US dollar has become the perfect safe haven for these “troubling times.” Even the White Rabbit himself would find this most curious.

    Black is white, Up is down

    As Fannie Mae and Freddie Mac are nationalized and become wards of the state (at a cost of $300 billion or more), the Federal government's balance sheet takes on another 5 trillion dollars in debt. This is apparently great news, as the dollar continues to move up dramatically. The markets must believe this and other bailouts to come must be good for the dollar.
    However, without foreign capital flowing into our Treasury in much larger amounts, how will the government pay for all this largess (and the largess yet to come) short of printing massive amounts of dollars? For the moment, who cares, when up is down and black is white?

    The Grand Plan in Wonderland

    Even in Wonderland there is a method to this madness. Some have theorized that the Grand Plan, hatched by Treasury Secretary Paulson and Fed Chairman Bernanke, was to use the excessive leverage in the hedge fund sector and force a massive de-leveraging, crushing the commodity sector, boosting the dollar and taking the pressure off the financial sector. A key benefit was to lower the cost of gasoline to hard-pressed consumers just before the election. The plan has seemingly worked very well, however it is likely just a “holding action.” And when the hedge funds have de-leveraged and dumped their commodity positions, what next? It would seem the wildly oversold commodity sector may just rebound, perhaps violently after the de-leveraging ends. Timing is everything, and Paulson and friends just want to hold off the cracks in the dike for another six weeks.

    The part of the plan about taking pressure off the financial sector hasn’t worked out quite as well.
    With the dollar soaring and commodities plunging, the financial sector has continued in its primary trend, falling off a cliff.

    Wall Street implodes

    This past weekend, the Federal Reserve and Paulson frantically attempted to broker a deal to rescue Lehman Brothers, the 158 year old investment bank that was established before the Civil War. There were no takers. Lehman is basically insolvent due to its massive losses associated with its toxic real estate derivatives. This once-proud institution has been forced to file for bankruptcy. In a brief fit of good judgment, Paulson decided not to bail out Lehman by adding further public funds to the hundreds of billions already pledged.

    When Bank of America passed on buying Lehman Brothers, Paulson and company pushed B of A to buy Merrill Lynch, another financial giant on the edge of bankruptcy. Curiously, Bank of America, after a few hours of due diligence, decided to overpay and buy Merrill for $29 per share, a 70% premium over the $17.05 close last Friday. When asked why he didn’t wait until Monday to get Merrill at a lower price, Bank of America CEO Ken Lewis stated “the strategic opportunity was so compelling it couldn’t wait.” Bank of America must now digest both Countrywide Financial and Merrill Lynch, while dealing with the challenges of its own balance sheet. The billions of dollars of toxic sludge that Merrill carries on its books now becomes B of A’s problem. Whatever happened to prudent banking? Just how hard did Paulson twist their arm? Perhaps Paulson would just like a weekend off once in a while.

    Trillions in liquidity evaporate

    As Merrill is swallowed, Washington Mutual, Wachovia and AIG are on cliff’s edge, ready for their turn to take the plunge. It is likely the veteran bankers in the Big Apple have never faced anything this bizarre in their careers. Two trillion dollars in liquidity has exited the US financial system this year, and three trillion world-wide. Without this vital lubrication, how does this system keep chugging ahead? The financial system has disconnected. It is ugly out there and likely to get uglier. Welcome to Wonderland.

And the downgrade on AIG is not helping either! AIG downgrade could prove costly

  • NEW YORK (CNNMoney.com) -- The pressure on troubled insurer American International Group intensified Monday night as a credit rating agency downgraded the firm.

    Another cut could prove very costly to AIG, which is scrambling to raise much-needed capital.

    Fitch Rating downgraded AIG to A, from AA-, saying the company's ability to raise cash is "extremely limited" because of its plummeting stock price, widening yields on its debt, and difficult capital market conditions.

    The company could be required to post $10.5 billion of additional collateral if it is downgraded one notch by one of the other major rating agencies and $13.3 billion of collateral if downgraded by both, Fitch said in a statement, citing AIG's July 31 estimates.

    Standard & Poor's late Friday warned it might downgrade AIG, placing the company on CreditWatch negative.

    Hoping to avoid such downgrades, state and federal officials raced Monday to help the insurer gain access to much needed cash. Credit downgrades could doom its business.

    New York State gave the nation's largest insurer the power to transfer $20 billion in assets from its subsidiaries to use as collateral for daily operations, said Gov. David Patterson. In exchange, the parent company will give the subsidiaries less-liquid assets.

    "It is simply giving AIG (AIG, Fortune 500) in effect the ability to provide a bridge loan to itself," said Paterson, stressing the company is financially sound and that no taxpayer dollars are involved.

    Meanwhile, the Federal Reserve asked Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500) to make $70 billion to $75 billion in loans available to AIG, the Wall Street Journal reported.

    However, any discussions are very preliminary, a source close to the matter told CNNMoney.com.

So gloomy?

Here's two quotes posted on Kirk's.

  • "When stocks pull back to their lows of the year -- in some cases, multiyear lows -- people avoid them like the plague. I don't get how it's different from a sale at Macy's. I mean, you don't see shoppers running away from sales when prices are marked down 50%, right? So what's the difference?" - Harry Schiller
  • "One of the many paradoxes of the stock market is that the worse it gets, the better it gets – at least, for those still able to invest." - Brett Arends

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