Monday, March 31, 2008

The Quarter Comes to a Close, Thank Goodness

The first quarter of 2008 will most certainly go down in history as one of most turbulent ones in modern financial history. Think about what has happened? ( in no particular order) The credit markets seized up leading to the collapse of the fifth largest investment bank, Bear Stearns. Banks and other financial institutions reported unprecedented losses. The stock markets around the world got rocked. The Federal Reserve went to uncharted territory through massive rate cuts, opening their window to investment dealers, and supported a bank purchase of an investment bank. Large private equity deals have and are going bust. Investors in ‘safe’ securities called auction rate securities lost access to their funds. Housing values continue to tumble. Thousands upon thousands of people across the country are and will face foreclosures on their primary residences. The US economy is most certainly in a recession while the dollar continues to lose value against other currencies and inflation and unemployment are on the rise. Sadly I could go on and on. No wonder people are not happy?

So what lies ahead? Most are just hoping that the worst is behind us but sadly, I do not think it is. The problems are big and it will take a while for it all to work out. In the mean time it makes sense to play it safe financially, investment wise and spending wise. That does not preclude looking for opportunities for long term investments, but it does mean that one should be sure to maintain enough liquidity to ride through the storm. And a storm there will continue to be.

I would like to offer a few words about the announcement today regarding a BLUEPRINT for overhauling the financial regulatory system. The timing of this announcement seems a little crazy to me. The government is clearly trying to send a message of ‘being in control’ but releasing a 200 page document which throws in to question the roles of all the regulatory groups that need to be focusing on the current crisis seems irresponsible. Knowing a little bit about human psychology I would suggest that threatening to change, if not take away, peoples jobs at the same time as you are requiring them to work harder then ever is not a smart thing to do. Hank Paulson said moments ago on CNN that it is his and the authorities number one priority to help manage through this financial turmoil and housing market downturn, and to me, they should be staying focused on that goal. Do we need massive restructuring of the regulatory system to create better alignment with the realities of today’s complex financial system, of course, but now is not the moment to throw the blueprint for that out there.

Tuesday, March 25, 2008

Is the Bear Stearns Deal "Fair?"

Case studies will be written on went wrong at Bear Stearns. There will be other studies about just what led to an unprecedented move by the Fed to broker the sale of the firm to JP Morgan on March 16th. Reams will be written about how a few days later that bid increased five fold to $10 per share. Though this deal looks likely to stick, the question of whether it is fair remains.

To whom should this deal be fair? Is there such a thing as a collective fair? And is that even the right question to ask? For the 14,000 employees who owned one third of the company, it would seem that $2 was the wrong price, and $10 is a better one, but with time what could that price have been? The authorities determined that their company was toast (unemployment), which is the only course of reasoning that could have led to the any-price-is-a-good price price. But when only one buyer is brought to the table, it seems virtually impossible for anyone to suggest that the price was fair.

To be sure, the buyer was given a weekend to do the impossible: determine a value of a complex financial institution at the center of the network of complex derivative transactions worth trillions. That process alone was likely not fair to the employees of Bear Stearns, but in those famous words spoken by Margaret Thatcher, “Life is not fair.”

As for the surviving banks and investment dealers, was $2 or $10 per share fair to them? If you were to apply the valuation metrics imposed on Bear to any of the many financial firms still standing and forced them to accept whatever price that implied, how would they have reacted? The same way Bear’s employees and shareholders reacted: they would be outraged! Luckily, by selling Bear off quickly, this outcome is unlikely, and you can be sure the survivors are breathing big collective sighs of relief.

What about JP Morgan, was it fair for them? My trader handbook tells me that if you know you are the only bidder, bid low. Period. There is simply no way Jamie Dimon would have done the deal had he not thought he was buying Bear cheap, and that, after all, is his job. He reports to the shareholders of the bank, and not the general public. His job was to secure the best deal possible for his company, and at $2 per share, even $10 per share, he has likely done that. Of course that does not mean that success is guaranteed, but a good trader assesses the risks and prices accordingly.

What about to the FED who backed the deal, was it fair to them? Are we kidding? They may well have pulled off the trade of the century. If the alternative, Bear going immediately down the drain, was the sure consequence, then a $30 billion guarantee was a steal. A few billion here or there is nothing compared to the economic consequences of a financial market meltdown. It is truly impossible to measure the cost of a failure of a financial institution the size of Bear Stearns and that is what continues to be cause for concern. The FED’s job is to protect the integrity of the overall financial markets, and that they did.

And what about the public? Please refer again to the paragraph above. If the financial markets collapsed, billions if not trillions of wealth would have evaporated in a heart beat. The US and arguably the world would have been thrown in to a recession. So yes, if the outcome was in fact the bank’s failure, this is a good outcome for the public.

These are difficult times. The Fed and other government authorities are clearly doing the best they can to ensure that financial markets stay fully functioning but this is not without consequence. Tough and thoughtful decisions are going to be needed when deciding who to save, and who not to. Save too many and you destroy the integrity of the financial markets, save too few, and we could yet experience a market meltdown. As we learned in the movie Bruce Almighty, you simply cannot answer everyone’s prayers even if you are God. What helps some often hurts others. Not only is life not simple, but often it is just “not fair”.

Monday, March 24, 2008

More on Bear and What is Happening with the Financials

As last week began, we heard that the Fed was stepping in to help JP Morgan buy Bear Stears for $2 per share after closing the prior week at $30. Prices for other financial firms initially skidded, in contemplation of who would be next to fall. Further, if Bear was only worth $2 per share, implying a market cap of less then one third of the value of their building, then what did that mean for the valuation of like firms? Not good. But that concern was short lived. By the end of the week, market participants had given the news an entirely different spin.

That spin went like this: The sacrifice of Bear meant that others would be saved. Hmmm… sounds a little like the message of EASTER? Bear, however, is unlikely to be resurected but existing shareholders did still get some good news today with JPM announcing they are now willing to pay $10 per share.

Many great commentaries have been circulating this week listing the reasons why we witnessed an unprecendented move by the Federal Reserve to fasciliate a buy-out. In “Let’s Get Real about Bear,” a commentary by John Mauldin,which you can only find via an email subscription which I highly recommend.( ), he suggests that “if Bear had not been put into sound hands and provide solvency and liquidity, the credit markets would simply have frozen this morning…Hit the Wall. The end of the world. Impossible to fathom how to get out of it type of event.”

The Fed clearly “got that”, and as the week played out, market forces grabbed a hold of the Fed as the lifeline not only for the financials, but for the market in general. (With the exception of commodites, which suffered a brutal pull-back this week.) They were clearly doing everything in their power to help stablize the financial system, and they did a good job. The questions still remain however, and I for one continue to have my doubts that the troubles are over.

For me, the biggest issue is that we are still very early in the default cycle of the laundry list of assets that are in fact in trouble. It started with sub-prime, but the list now includes all residential mortgage product, commercial real estate loans, construction loans, credit cards, student loan debt, home equity loans… and the list goes on. I have heard some alarming statistics including that 30% of all homes bought in 2005 and 2006 are underwater (meaning, home is worth less than the value of the loan). Mauldin, in an earlier newsletter, suggested that in order for housing inventories to find clearing levels over a reasonable time frame, prices would have to fall another 15% from here, wiping out over $5 trillion in home equity. The banks have already taken some big write-offs but it is unlikely that they are done. With the Fed’s help to boost prices, it is hopeful that they can raise the capital they need to not only weather more write-offs but to keep the lending machine going.

The other issue that continues to worry me is counterparty risk. Bear was too big of a counterparty to let fail given that they were a huge player in the derivatives space, but others will fail, and it is unknown what will happen when they do. The bet is, of course, that the Fed will continue to do everything in their powers to keep stability in the system, but can they? I believe that the Fed can and will prevent any sort of systemic collapse which they may have witnessed had they not come to the rescue of Bear. But there will be more problems. Exactly how and where is a difficult bet indeed.

Last note. Be sure to pick up a copy of The Economist this week to catch its feature on Wall Street. This magazine is simply the best way to keep up with what is happening in the world and I would highly recommend a subscription. They also found the Fed’s mover reassuring but “the nature of liquidity in today’s ready-cash funding model of investment banking is that it is strong until suddenly it is not.” I share the sentiment reflected in their closing statement that “with housing prices still falling, credit deterioration spreading and derivatives markets deeply unsettled, is anyone willing to bet that Bear Stearns is the last of the $2 sales?”

Sunday, March 16, 2008

JP Morgan takes Over Bear Stearns and More………..

As I sit down to write this piece news just hit the tape that JP Morgan will buy Bear Stearns for $2 a share having closed on Friday at $30 down 47% on the day. “The deal marked a 93.3 percent discount to Bear Stearns' market capitalization as of Friday, and roughly a 98.8 percent discount to its book value as of Feb. 29… or 1% of what the company was worth 16 days ago” reports ( ) Bear was too big to fail and the FEDERAL RESERVE came to the rescue. Barron’s reports that it is “tough to say what Bear is worth” but they highlighted two spots of value, their prime brokerage business which “generated $566 million in pre-tax profits last year. At six times earnings an appropriate multiple would be $26 a share.” Add to that the value of their office building which they say is worth $12 a share and it might seem that JPM is getting a bargain. Not so fast. What this more likely means is that the value of their asset base is at least $36 a share worse then people think. Bear’s asset base at the end of November was $395 bln, with only a $12 bln book value that implies some 30 times leverage.

The folks who spent the weekend at the firm trying to ascertain the value likely had no easy task and it is unclear what will happen to those assets this week. Though the language is sketchy it appears that JPM has a made a deal with the FED for ‘special financing,’ which may mean there will be no forced selling which could have made problems even worse. From everything I read over the weekend, and listening to Treasury Secretary Hank Paulson’s on FOX NEWs today, it was clear that the FED and the Treasury will continue to do everything they can to stabilize the markets. The question remains, can they do enough to prevent further problems? The answer clearly has to be NO WAY and the most they can hope for is to try to keep it somewhat orderly. The massive deleveraging has to run it’s course, and we are not even close to the finish line. I applaud both institutions for what they are doing, but it won’t be enough.
The reason for saying this is because FED loans, albeit helpful, do not solve the core problem. The lack of transparency coupled with the incredibly complexity of financial instruments has rendered balance sheets nearly impossible to analyze. Free markets can only function in a system where a company’s credit worthiness can be assessed independent of a letter grade supplied by a rating agency. However, the truth is that this is simply no longer the case. And, in times of stress, any prudent buyer will charge a huge discount to compensate them for uncertainty, especially when a company leverages it equity twenty or thirty times. Is Bear Stearns worth $2/share. Who knows? I’m not sure that even JP Morgan knows. However, before one can declare that this financial crisis is over, the markets have to be able to make this kind of assessment. Unfortunately, we are not there yet.

Weekly Market Performance and Benchmarks
DJ Indus close 11951 +57.40 +.48% -9.9% ytd
S& P 500 close 1288 -5.23 -.40% -12.2% ytd
Crude Oil 110.21 last week 105.16
Gold 998.10 last week 972.20
10 Yr Treas 3.43%

What To Watch This Week
- Other investment banks are reporting earnings – Goldman, Lehman and Morgan Stanley. Question is, how bad will it be? The market will be watching all financial institutions closely, worrying about who might be next to go.
- There have got to be other hedge funds in trouble, I am sure they will start to surface.
- The FED meets on Tuesday for an expected cut of the fed funds rate to 3%.
- The Fed is clearly going to continue to pump the system with liquidity which should be good for Gold and bad for the US Dollar.

Friday, March 14, 2008

WSJ - A Must Read

David Roche wrote an exceptional OPED called "Recession Is Inevitable" which articulates the response of the FED to problems in the system. Though doing all they can do, they cannot stop what is happening now that we are in "the contractionary (bear) phase of the cycle." His outlook is quite negative as a result. "Globally, total credit losses of $1.4 trillion will cause a contraction of world GDP of 2.5 percentage points, or half the current rate of global growth. So the global economy will become a gray, dull world of semi-recession and sticky inflation that will last a long time. Without major policy blunders, however, it won't be a 1903s-style depression."
For the whole article


Was it not a couple of days ago that the head of Bear Stearns went boldly on CNBC to say everything is ok? Bear Stearns stock is down 45% on the day (as of 11 am) on news that they are unable to fund themselves.

The term auction facility that is suppose to provide the likes of BEAR STEARNS with liquidity does not open until March 27th and they found themselves in an immediate need so they had no choice but to go to the FED immediately. JP Morgan is a conduit for the funding, as being a bank, they have access to the FED window. According to CNBC they are taking no credit risk by serving as the go between.

"The most unbelievable, selective action by the FED that he has every seen." Says Cramer on CNBC, the guy is going even more crazy then usual. But what choice did the fed have?

This is bad, very very very bad…….and sheds a very dark shadow about the problems likely being faced but a large number of financial institutions. ( banks, broker dealers, hedge funds, insurance companies .... and so forth)

The problems are far, far, far from over.

Tuesday, March 11, 2008

US Equity Markets Take Off -

If I would have been writing this piece yesterday I would have been telling you about what a horrible week the credit and equity markets had. The worst yet. There were "convulsions in the credit market" with firms being unable to fund regular business deals. Thornburg Mortgage and Carlyle Capital caught the headlines, but be sure there were others. On the equity side the economic news also got worse, with the headline that 63,000 jobs were lost in the US in Feb. Some noteworthy economists finally threw in the towel and said yes indeed, we are likely in a recession.

As far as I can tell, and granted I did just spend the day skiing with my kids, the only thing that has really changed is that the FED said they are going to inject as much liquidity as they can in to the system to keep the financial markets from blowing up. That is the same thing they have been saying forever. It looks now like they are making more money available to more players, which is a GOOD thing, but the problems are not going away. Bad assets are still bad assets, and they are still going to have to work their way through the system. What they said by this action is that things are SO SO SO BAD that we need to come to the rescue even more then we thought last week. Again this is a good thing, and should help stablize the markets from a free fall, but does it suggest that all is ok in Wonderland? Not at all.

I do absolutely congratulate the FED for this program and it makes a lot more sense to me then continuing to rachet down short interest rates. It also makes a lot more sense then the government throwing handfuls of cash out an airplane window. The FED is acting responsibly but my point is that it is not enough to stop the workout that has to take place, they are just trying to help it be more orderly.

Friday, March 7, 2008

Goldman's 10,000 Women Initiative - New on the Hufffington Post Piece

There is so much to say about Goldman's new initiative that it has taken front and center stage for me over the nightmare that is unfolding in the markets. For reasons to smile follow the link.

The economic news continues to be horrible and the markets are reacting accordingly. My view continues to be incredibly defensive.

Goldman, Meet Chris Grumm

On the heels of that last post, I must share something written by a woman I believe to be one of the most amazing people in the social justice movement, Chris Grumm. Chris did not have to work very hard to get me to join the Board of the Women’s Funding Network. She is one of the many women I have met over the past few years who has been walking the walk and talking the talk for a very, very long time.

Chris writes:
“We have an open window at this point and time in our history. We see the building of popular interest in investing in women and girls. Examples of this are Oprah’s school for girls in South Africa, Care’s worldwide campaign “I am powerful”, UNIFEM spokesperson Nicole Kidman talking about women around the world and Tyra Banks, US former model and TV host, work on supporting young women of every race, class and beauty. Even the Millennium Goals for Development have started to realize the need to focus more on women and girls if they want to reach their stated goals....Women have more education, money, influence and political power than any time in history. And people around the world are dissatisfied with much of their current leadership, and are calling for something new. The world is ripe for change."
So BRAVO Goldman. BRAVO for launching something symbolic in the women’s space and for so boldly joining our club, the Women (and Men) of the Social Change and Social Justice Movement, we are happy to have you. May we work together for a long, long time to come.

Thursday, March 6, 2008

10,000 Women : A Goldman Sachs Initiative

Yesterday was a day I will remember for a very long time. A few days earlier I received a phone call inviting me to a special press announcement by Goldman Sachs at the Low Library at Columbia University. I was told very little except it was ‘right up my alley’ and was something that would make me very proud of the firm. With a certain degree of skepticism, and a slight bit of annoyance due to having to arrange my schedule, I said, “sure, I'll be there.” I would not have missed it for all the bags at Bergdorfs.

Walking up the commanding steps of this most magnificent structure I entered unprepared for what unfolded next. As I worked my way through a maze of people and cameras, the stage opened up, and staring at me were the faces of the most beautiful women, and the number 10,000. The brilliantly designed set,merged the ticker tape style of Wall Street with more personal and grass-roots images of women from all over the world.

10,000 Women , A New Goldman Sachs Initiative

I quickly spotted many familiar faces. The middle few rows were occupied by the handfuls of senior women at the firm, many of whom I knew well from the time I was there. Other retired partners had been called back for this very special announcement as well.

Within a few minutes, and after about 30 people paraded on stage behind him, Lloyd Blankfein, CEO of Goldman Sachs, took center stage to tell us why we had been summoned. Goldman Sachs was announcing a brand new initiative that “will provide 10,000 underserved women, predominantly in developing and emerging markets, with a business and management education.” Why? Because he, they, Goldman Sachs, the firm that gave me my start in the business, the firm I worked with for fourteen years and gave me the honor of being a partner, had come to believe that the way to change the world for the better was to economically empower women. Here they were making a considerable and creative commitment to do just that. Damn right that was "right up by alley.” I was floored.

For the next hour, we heard more about this ambitious program from the people that were going to make it happen. The deans of Business Schools from the global North and South talked about their programmatic partnerships. A few women who would would benefit from the opportunities Goldman was creating for them shared their stories about what having a business education would mean for them.

You see, by providing a woman with a business education and other resources you enable her to not only improve her life, but her family’s, her community’s, her country’s and thus the world. As an activist and donor in the women’s space, of course I had heard this logic pattern before, but the power of witnessing it behind a Goldman Sachs podium was deeply personal and incredibly powerful. Goldman Sachs, the pre-eminent Global Investment Bank, called all these people together to tell them, and the world, that we MUST invest in women not only because it is the right thing to do, but because it makes good business sense. Though they had made this case internally to themselves for years and years prior--indeed, this message has been the primary driver for their diversity efforts--they were now saying it in a broader context, and on a world stage.

I remember reading a quote not long ago that left me deeply annoyed. It went something like, “It will take a man to lead the next wave of the women’s movement.” The sentiment, I believe was that what the women’s movement needs is for someone to put it where it belongs, front and center; given the style of leadership that it would take, that someone would likely be a man. Internally I thought WRONG, big WRONG, our movement doesn't need a man. But I do believe we need men, to work alongside women leaders, to lead the next wave of the women’s movement that is already well underway. We need both genders at the table to lead the kind of change that makes this world a more just and equitable place for all. Moreover, we need institutions in the public, corporate, and non-profit space to work together for change.

Philanthropy and social change is not something to do after you leave your business life. It's something you can combine with your business life. Leave it to Goldman to help show us the way.

Tuesday, March 4, 2008

"Leveraging the Power of Race & Gender"

This is the title to a piece written by Kavita Ramdas, President and CEO of the Global Fund for Women, ( ) for the NATION. This piece is a must read ( ) in the context of the current Presidential election. Kavita is a brilliant leader of the social justice movement and I am honored to serve with her on the Board of the Women’s Funding Network. ( ) She so eloquently expresses what many of us our feeling about the missed opportunities in the current political debates. Both Clinton and Obama have an incredibly opportunity to talk a very different kind of leadership, pulling from the richness of their personal histories and perspectives. Why are they not doing that? Let me leave you with the last paragraph in hopes it will inspire you to follow the link and read the whole piece. Bravo Kavita!

“The next President needs the ability to demonstrate the inner courage and conviction that comes from owning his or her "otherness." As a woman and a mother, Hillary Clinton could bring insights and perspectives no other President in US history could have brought to the negotiating table of war and peace. As the stepson of an Indonesian Muslim and the son of a Kenyan and a white woman from Kansas, Barack Obama manifests what it means to be a global citizen. What is at stake in this election is not merely the historic first that would be accomplished if either a black man or a woman became the next US President. What is at stake is the fragile future of our shared world. “ – Kavita Ramdas.

Sunday, March 2, 2008

The Bad News Continues

Alan Abelson from Barrons called the news this week a continuation of the “extraordinary litany of woe” and I would have to agree. Though the equity markets tried to enjoy a bounce at the beginning of the week off good news about the monoline’s credit ratings, the economy once again took center stage on Friday. Although the President and his advisors are still in denial that we are in fact in a recession, the rest of the world seems to be of that belief. Given the evidence, it would be tough to argue. More and more we are reading about the possibility of stagflation which I have written about a few times over the past two months. To quote Alan- “Gold.. has proven a much better gauge of inflation that any of the laughable official measure our blessed government uses.” In case you missed it GOLD hit a high of $978 this week and more and more people think it will break $1000. I happen to agree. Over the past year oil is up 62%, soybeans up 88%, and wheat is up 164%. Sugar a staple in American’s diets is up 30% in the past two months alone. No inflation? Ya right….

And what about the credit markets?? The stories keep getting worse, much worse. The municipal markets are still a mess, pretty much all credit products is trading at it’s widest spread levels in forever, and hedge funds are starting to blow up left, right, and soon to be center. Lucky for them many of them can say “sorry you cannot have your money back.” I guess if they can do that in the muni market these days, why not hedge funds. I think everyone is going to start reading the small print.

A couple of headlines that I found particularly noteworthy this week:
- A USA Today headline on Friday that said – “More Americans are using credit cards to stay afloat.” People are forgoing paying their mortgages in order to keep their credit cards current. That has never really been the case before but because housing prices have dropped so fast, and people living at the margin have so much debt as it is, they are thinking that they need to keep their credit cards or they cannot buy everyday necessities. I have said it before but I will say it again, every type of credit product will experience record delinquencies in the coming year, and credit cards will be one of them.
- The Economist reported that “8.8 m mortgage holders, 17% of total, have home loans greater then the current value of their home.” ( Mark Zandi of Moody’s – This number is BEYOND shocking. BEYOND.
- Fannie Mae and Freddie Mac – Please do not get me started! Despite them both recording record losses in the billions regulators decided that they should be able to grow their portfolios as much as they want. According to BARRONS Fannie’s portfolio is 81 times it’s net work and Freddie’s is 167. Remember that although these agencies do provide a valuable service by reducing the cost of mortgages to American homeowners, they are also operate very much like hedge funds. One might even suggest that they are a government sponsored hedge fund. With leverage of 20 to 1 and 30 to 1 respectively, compared to the average hedge fund in the single digits, if they were private investors would have pulled out their money a long time ago and the regulators would have shut them down. But NO … let’s tell them to buy more.

Only in America.