Posted by September 22, 2008
Given the outright chaos of last week, this weekend’s events seem tame, even as Goldman Sachs and Morgan Stanley changed their charters to become bank holding companies. This effectively ends the era of independent investment banks which started in the 1930’s as a result of the post-Depression law known as Glass Steagall, which mandated that banks become separate from investment banks, which isolated underwriting stock offerings from bank deposit insurance. The Glass Steagall mandated separation actually was removed in the last 1990’s when authorities allowed Citibank to merge with Smith Barney along with the introduction of Financial Holding Companies and the Graham-Leach-Bliley Act. With the charter change, the Federal Reserve will become the primary regulator of Goldman and Morgan Stanley, which heretofore has been under the jurisdiction of the Securities and Exchange Commission.
Of note, this change resonates with me personally. My department appeared to be winding down before Lehman. Now it is readily apparent that if I want to continue with this “Primary Dealer Monitoring Effort” then I will have to join Bank Supervision and leave the Markets Group. Of course, I’m not sure that Bank Supervision wants me. I expressed my career anxiety concerns to my soon-to-be ex-boss and he told me don’t worry – there’s plenty of work in the bank and my skills should be in high demand. Although this message wasn’t a surprise, I was delighted to hear it. I guess if worse comes to worse, I can likely return to the Desk as a Trader / Analyst and grin and bear those am Briefing rotations. !:-0
Returning to the ever-present gloomy price action, the stock market was down 3.8% today. Presumably the market is waiting for details to emerge on Treasury’s plan to buy distressed assets. This program could be super-helpful, then again it could be very bad. Morgan Stanley’s stock price was unchanged – maybe the “run” is ending? – but there was more bad news in the credit space: further downgrades of the once high-flying Washington Mutual bank and, get this, Fitch downgrades General Motors to a ‘CCC’ rating, which means they think GM’s chances of defaulting within a year are greater than 50%. We’re talking General Motors here, for goodness sake!! Is another government bail-out on the horizon?
September 24, 2008
My boss confirms that he will become my ex-boss soon – he’s returning to the Fed’s research department. As I ponder my fate, there’s plenty to consider in the credit markets as I recap the events of the last two and half weeks:
- Failure of Lehman Brothers
- Merger agreement between Bank of America and Merrill Lynch
- Government injects $85 billion into AIG, in exchange for 79.9% ownership
- The Reserve Fund, becomes the largest money market mutual fund to ever “break the buck” as a result of losses on its investments with Lehman
- Treasury agrees to “insure” money market mutual fund shareholders for free.
Then we have the expansion of the Fed’s liquidity facilities:
- the Asset backed-Money market Lending Facility (AMLF) which lets banks buy asset backed Commercial Paper assets from money funds and immediately off-load these assets to the Fed with no risk
- expansion of the eligible collateral that can be pledged to the Fed into the Primary Dealer Credit Facility (PDCF)
but, I digress. The main point I want to convey here is that the short-term fixed income markets, the so-called money markets, are behaving very unusually as banks appear to be “hoarding” liquidity, even though it’s costing them money. The only lending that is occurring between financial institutions seems to have an overnight maturity ! This argument of impaired market functioning has some credence but it’s a little abstract when compared to the considerable pressure that Morgan Stanley has been facing. The price of their Credit Default Swaps increased by about 200 basis points today to about 750 basis points while, unlike yesterday, Morgan Stanley’s stock price was down 11% today. Meanwhile, Goldman Sachs found a friendly “deep pocket” as Berkshire Hathaway made a $5 billion investment, with the option to go to $10 billion – good for them, likely even better for Berkshire Hathaway.
Meanwhile congressional debate continues over plans to create a Resolution Trust Company II, which is now being referred to Troubled Asset Relief Plan, or TARP. The debate has changed market expectations that the deal can be completed quickly. Believe it or not, I’m all for the delay. It’s much better to “get it right the first time”, even though getting it right may take a considerable amount of time. Treasury Secretary Paulsen’s “bazooka” analogy is all well and good, but you still have to aim the bazooka at the right target. Perhaps needless to say, this issue is complicated:
- What assets should Treasury try to purchase?
- Who is going to determine “reasonable prices” (in a distressed market), and how will the purchases be executed?
- Who will be eligible to sell assets to the Treasury?
Secretary Paulsen’s initial statement to Congress is that they should allocate $700 billion for these purposes, carte blanche, no strings attached. To make it just a little more complicated, the presidential election is less than two months away which means that, in addition to a new president, the country will also likely have a new Treasury Secretary as well. How much sense does it make for Congress to grant discretionary spending authority of $700 billion to an unknown future Treasury Secretary? I’m just asking, I think the reasonable answer is NO SENSE AT ALL
September 26, 2008
So let’s see, it’s now ten business days since the Lehman collapse. Here’s a summary of what’s happened over the past two days:
Republican Presidential Candidate John McCain suggested that today’s presidential debate should be cancelled as he returned to Washington to help solidify a broad-based Congressional coalition to ensure that Congress passes the best TARP bill possible. Sad to say, in what may be an omen of future political disfunction, this sensible gesture was met with immediate derision and actually prompted an increase in partisan rhetoric and a delay in the passage of a TARP bill.
The FDIC closed the doors on its largest bank resolution ever, Washington Mutual (WaMu), which had over $300 billion in assets. Soon thereafter, JPMC bought WaMu’s loan portfolio and all its retail branches for $1.9 billion. The seemingly low purchase price is deceiving, however, as JPMC immediately wrote off $30 billion in assets and announced plans to raise an additional $8 billion in equity. Given this fact pattern, WaMu’s pre-existing capital base (senior debt and equity) stands little chance of getting much of their investment in WaMu returned. The WaMu news was yet another “tale of two cities” – it was the best of times, it was the worst of times – news event for the stock market. Shares of JPMC surged 11% and Bank of America’s shares increased 6%. Meanwhile the sense of impending doom became all too real for several large regional banks including Wachovia Bank (down 27%), National City Corp (down 29%) and the continuing Morgan Stanley saga (down 8%). Morgan Stanley’s credit default swap pricing now requires a substantial upfront payment ( ~ 17%) to purchase their default insurance.
Market attention is now squarely focused on Congress and the potential for them to pass the Troubled Asset Relief Plan. What will be the shape, depth and breadth of such a plan? Can Congress possibly get its act together over the weekend before the markets open in Tokyo?
I do want to add more tidbit of information which is interesting to me because it may affect my so-called career. The SEC announced today that it was ending its voluntary regulatory program known as regulating a Consolidated Supervision Entity (CSE) because in their words, “voluntary supervision doesn’t work”. Not coincidentally, all the large dealers have either merged with banks (Merrill Lynch), gone out of business (Lehman and Bear Stearns) or changed their charters to become banks (Morgan Stanley and Goldman Sachs), so there is no longer a need for the SEC to supervise CSE’s. Always on the leading edge, that SEC ;-). With this news, it becomes official that if I want to continue in my current role at the bank, I will have to “cross the line” and go to work in Bank Supervision. Not sure if they even want me though. Finally, this announcement means that I attended the last ever CSE “Market and Credit Risk Update” meeting a couple of weeks ago at Merrill Lynch. The topics of conversation at the meeting were so out of touch that I couldn’t bring myself to actually write up summary notes for the meeting.
September 29, 2008
What a mess! I was initially encouraged in reading the big headline in today’s WSJ: ‘Crisis Hits Europe’s Banks as US Seals Bail-out Deal’. The headline proved to be false, not the European bank part, of course, they are a mess, it was the bail-out deal details that proved disappointing. Staying with Europe, the UK assisted with the bail-out of a large mortgage lender, Bradford & Bingley, Iceland shored up its third largest lender and Germany provided about $45 billion in support to the Hypo Real Estate Group. Perhaps the biggest news was that each of the Benelux countries (Belgium, Netherlands and Luxembourg) were going to purchase 49% of the Fortis Bank Group to try and stabilize deposit flight. As if that wasn’t enough, just before the opening of the New York financial markets on this Monday morning, the FDIC announced that it was providing assistance with the sale of Wachovia to Citibank at the lofty price of $1.00 a share. Although Citi will assume all of Wachovia, they will get some “downside protection” should losses be more than expected on a segment of Wachovia’s assets that total $320 billion. If this asset pool has losses of more than $41 billion (15%) then Citi can “put” the excess losses to the FDIC, in exchange for a 12% equity investment in Citi.
Shocker! The equity market was not happy to hear about the over-weekend government sponsored re-capitalizations of five very large banks. Wachovia was the fifth largest US bank with over $800 billion in assets – now its apparently gone. In response, the stock market opens down about 3.5%, but at least we can take some solace in the Congress endorsed bail-out plan, right? WRONG. Turns out the House of Representatives rejected the TARP legislation which sends equities into a tailspin: Dow Jones Industrial Average declines about 6.0% with the S&P 500 declining about 7.5%. The Dow Jones index is now at a 4-year low, but there’s always tomorrow.