Monday, September 15, 2008
A Historic Day for the Markets
How do you begin to describe what went on today in the financial markets? There was no doubt that it was going to be a tumultuous one and of course it was. Lehman Brothers. First and foremost my heart is broken for the thousands of people who lost their jobs and a substantial part of their savings. Second this should be an example of how you cannot wait to find a solution to your problems in these markets, or the market will take you down. Third I am hearing from hedge fund friends that there is a lot of confusion out there as to how trades with Lehman will settle. All just not good.
On to Merrill. First and foremost John Thain is one of the smartest people I know, and more importantly he is a really good guy. I am sure it was very hard for him to have to sell the firm he so recently joined, but I have no doubt that he got the best deal he could. The fact that the deal was struck way above the closing price on Friday is testament to that. I now get why the deal makes sense, and I did not really understand it last night. Simply put they had no choice. With Lehman gone the market was going to take a run at the next I Bank in line and that would be ML. Cudos to Ken Lewis for not being piggy piggy and buying ML at a higher price then he probably had to. I believe that should help moral a lot. This merger does make business sense.
On to AIG. They are in big do do. I think the market was hoping all day that they would come up with something and the fact that they did not helped the market to close at the lows. The fact that so many of the banks are working hard at a solution says that AIG failing would be a big problem for them. The issue is counterparty risk in the massive derivatives market in which they are huge players. I believe their balance sheet is in the hundreds of billions, if not a trillion... people are going to be asking "where were the regulators?"
On to Goldman Sachs. Goldman did the right thing early on. They recognized there was a problem and they took quick action by pairing down positions and taking their lumps. The challenge there after was to try to keep the junk off their balance sheets when their customers were blowing up around them. As a trader I know that is a very, very hard thing to do. In theory you are there to provide liquidity to your clients, but when you don’t have it on the other side, ( ie no one to sell the stuff to ) what do you do? What I use to do was to either try to miss by a little, or have a serious conversation with the client to say “look you know and we know this is bad, here is the price where we can do it and it has to be kept quiet.” I am sure GS did some of both. I am hearing that there is next to no liquidity in anything right now on the fixed income side and in time this will be very good for whoever is left standing. Longer term the fact that competition has been reduced and spread has returned is a good thing. Further people are saying that GS will not survive without having access to a deposit base, and that might well be true. I think it is more likely that GS finds a way to buy a bank then the opposite. My other bold call is that GS finds the funds, perhaps in partnership with some big PE players, to buy a bank.
On to the FED. I am going to make another bold call that they are going to cut rates tomorrow, maybe even sooner. What choice do they have? By opening up their discount window to more and more types of collateral they are saying that we are going to provide liquidity to the market. Period. I don’t believe they should step in to help AIG directly, but by helping the banks, they are helping AIG. They should not give a hoot about inflation right now and just do whatever it takes to reduce the probability of both a major financial crisis and a depression. They need to inflate asset prices, in particular housing. Think of how many problems would do away if they facilitated a bottom to the housing and commercial mortgage markets. They should also create something like the RTC to take on the bad debt. This is where the Fed is missing the boat I think. Bad assets have to go somewhere to be worked out and the sooner the better.
Last the hedge funds. This is a wild card and because of the lack of transparency it is very hard for anyone to know what their positions are, howthey are marking those positions, what their counterparty risk looks like and thus what they are likely to do. One hedge fund, Long Term Capital, created chaos 10 year ago and now there are over 9000 hedge funds out there operating and many of them are huge. Providing liquidity to the market will of course help this situation.
I think tomorrow is going to be another very volatile day, not to mention over night. With the Asian markets closed today I am sure they are going to open very soft.