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September 2008, Part I
No better way to look back at the financial crisis, one year ago, then the archives of StocksandNews, specifically my “Week in Review” columns. The week of 9/15/08-9/19/08, I was down at the Jersey shore, expecting to relax. Instead I was glued to the tube all week with the only break being short walks on the beach. I filed some of the following from Avalon, New Jersey, 9/20/08.
I have long railed that when it came to foreign policy and our policy regarding Israel and the Palestinians in particular, the United States has not been an honest broker. And today, we have now proven that when it comes to the global financial system, the U.S. has been a dishonest broker. We peddled our garbage all over the world, and seeing as we are supposed to have a monopoly on financial genius, the world ate it up. This week, collectively, the world spit it all out. It was as if the U.S., as is the case in China today, laced its financial instruments with melamine, a chemical used in fertilizer that some Chinese infant formula producers substituted for protein in an attempt to cut costs. Wall Street’s mavens thought they could get away with their skullduggery, and indeed for years many did, but in the end everyone gets caught….
So what happened this week, or rather the past few weeks and months, going back to the collapse and bailout of Bear Stearns in the spring? It’s really incredible how the landscape has changed. No more Bear; Fannie Mae and Freddie Mac, bailed out; 158-year-old Lehman Brothers, gone; 94-year-old Merrill Lynch, no longer independent; the world’s largest insurer, AIG, bailed out. And the fate of stalwarts such as Goldman Sachs and Morgan Stanley, as well as the biggest savings & loan, Washington Mutual, and powerhouse regional Wachovia, at one point or another hung in the balance….
[For] me it’s always been about lack of transparency, and, through my own extensive Wall Street experience, where I was in positions in the fund industry subject to regulation, the lack of same when it came to many of the Street’s practices.
It’s been about leverage, massive amounts of it, not just on the part of our financial institutions, but at the individual level as well. It’s also been about accountability, again, both institutionally and individually.
This week, New York City Mayor Michael Bloomberg slammed the “I want it now society,” adding “We lost the moral compass of saying no to the people who did not have the earnings capacity to support a mortgage.”
That pretty well sums up the accident that was waiting to happen on the housing front when it came to Mr. and Mrs. Jones, who were offered subprime, Alt-A, and option adjustable-rate mortgages that in so many cases the homeowner didn’t have a clue as to how it would impact their financial future. But when it then came to Wall Street, it was about packaging each and every home in America, including beaver and bear dens it would seem, into some kind of structured product; product that Archie Bunker, were he still alive, would have properly described as “crapola.” But we bought it…and then for this past year or so it’s been a game to see who’s the last one left holding the bag? Despite all the action taken by the federal government this week, when it comes to the likes of the defunct Lehman Brothers, or Morgan Stanley, for that matter, we are far from knowing where all the bodies are buried. And through it all, the regulators and boards of directors were asleep; in the case of the latter gorging themselves on fois gras at the meetings, one can assume, while the CEO had maidens feeding his hand-picked buddies grapes and supplying other tender favors.
For its part, Washington wasn’t any better, a veritable plethora of buffoons, as best exhibited by those striding before the microphones this past week, including John McCain. It is utterly amazing how a McCain or Joe Biden can reside in such a position of power, for decades, and with access to the best experts in the world, yet emerge from the experience with a brain full of nothing but air when it comes to financial matters.
It was also amazing that Sen. McCain said the American economy was fundamentally sound. Oh, I know, this is a typical Republican talking point, but in the span of 24 hours on Thursday in particular we learned that not only was the U.S. economy not sound, but the entire financial system was on the verge of total collapse.
You see, credit – the mother’s milk of economic activity, right down to those new microcredit programs for the poor in India and Africa one man won a Nobel Prize off of – had totally seized up. Interbank lending, the first step, had ceased to exist and if the banks wouldn’t lend to each other, suffice it to say you and I wouldn’t be able to obtain a car loan, or my favorite microcaps a business loan, or some large corporations the ability to finance their payrolls on an ongoing basis through what were once simple commercial paper transactions.
And it is those very commercial paper instruments that are the lifeblood of money market funds (that and short-term Treasury and other corporate securities). Suddenly, with all the uncertainty created by a seized up credit market, institutions, first, and then individuals, launched a near run on the bank; those very same, safe money market funds you and I never gave a second thought to when gauging our financial security. It all started when the father of the money market fund himself, Bruce Bent of the $62 billion Reserve Fund, realized, ‘Omigod, we have Lehman paper in our fund!’ and in marking it to zero caused the net asset value to break the cherished buck. FIRE!!!!
Institutions began to flee a Putnam institutional money market fund that was then forced to close, others were pulling their money from other offerings, fleeing in panic, as money then moved into one and three-month T’bills, with the cascading demand for the safest paper imaginable, at least for the moment, causing yields to approach 0.00%. But at least it was safe. Capital was preserved.
Amidst the near stampede, however, came word that Hank Paulson, Goldman Sachs alum and Treasury Secretary, had seen the light and it was now time to save the Free World, and the authoritarian one for that matter, seeing as Russia, China and a bunch of shady Middle Eastern nations hold a ton of our debt, the rapid selling of which would only exacerbate the problem, by offering to bail out everyone from every obligation he or she ever had in their lives. It wasn’t just pure coincidence that Alex Rodriguez and wife Cynthia reached a divorce settlement the same day, you understand. Paulson swooped in to clean up that mess as well.
OK, strike this last one from the record, and the bit about any obligation us schleps ever had in our lives. What Paulson did do was bail out the banks, first and foremost; offering to take in all their toxic crapola under his great robe, like the Ghost of Christmas Present. ‘Come here, my children, and I’ll shelter you from the storm.’
Of course under Paulson’s robe already resided the remnants of Bear Stearns, some $29 billion worth, and $85 billion from the just rescued AIG, and perhaps up to $200 billion for bailing Fannie and Freddie. What will be the cost of taking on all the other bad paper, plus insuring the lion’s share of money market funds, yet another of his steps? We’ll learn over the coming weeks… and here I’m invoking my 24-hour rule. Suffice it to say it’s a lot, as in $100s of billions, though the Fed and some experts can legitimately argue the government could make money on many of the rescue projects. Let’s hope so.
But at least in the short term the bills for the taxpayer are going to be humongous, this on top of a Fiscal 2009 federal budget deficit that Paulson’s own Goldman cronies have estimated to be in the $565 billion range. In fact, the potential add-on cost is truly unfathomable. Let us hope the result of Paulson’s war on the free markets isn’t like that in “The Christmas Carol,” where in our case the Ghost of Christmas Yet to Come shows us a tombstone with a simple inscription… “Here lies Adam Smith, author of ‘The Wealth of Nations,’ model for the American Dream, 1776-2008.”
For the archives and my running history of our times I need to get down some other thoughts before advancing to Street Bytes.
What does all of the above have to do with the economy, here and now? If we take out our three-legged stool, the consumer, housing, and capital spending, clearly, even if some form of confidence returns, especially if Wall Street continues to rally and housing bottoms, as I see early next year, the consumer has been dealt a severe body blow and to compound matters corporate America is continuing to retrench, save some tech sectors it would appear (see SAP’s and Oracle’s recent performance), so spending is bound to remain punk. [Lower energy won’t bail us out in this regard.] The house, once a piggy bank, is no longer. The Christmas season will be a disaster and my recession forecast holds….
--The Federal Reserve actually met this week and opted to keep its target funds rate unchanged, expressing an ongoing concern with inflation even as the economy teeters, a stance that PIMCO’s Bill Gross called “otherworldly,” as in the Fed is clearly on another planet in holding this view.
--Lehman saw its shares tumble to zero amidst the largest bankruptcy filing in our nation’s history, down from $85 in early ’07. Despite up to 10,000 employees in the capital markets and investment banking divisions being rescued by Barclays, and perhaps more employees out of a total 26,000 by other outfits, the fact is a staggering amount of wealth was wiped out. This, like in the case of Bear Stearns, and massive layoffs in the industry overall, has a ripple effect that is in some respects the true heartbreak…the dry cleaner, the waiter, the driver for the car service, the coffee cart guy.
It is just incredible that Lehman CEO Richard Fuld couldn’t see the coming train wreck and, having had six months since the collapse of Bear Stearns to address his firm’s problems, did nothing. But it’s no surprise the Lehman board did an equally poor job.
--Merrill Lynch, with 60,000 employees, was rescued by Bank of America in a deal initially valued at about $29 for Merrill shares, stock that was once $98 in ’07. Many layoffs on both sides are a certainty here.
--In Britain, HBOS, the largest savings & loan in the country, was forced into Lloyds TSB’s arms owing to its massive mortgage exposure. 40,000 layoffs could be the result here.
--AIG, with a presence in 130 countries, and counterparty risks in same, and with 80% of its life insurance and retirement program premiums from overseas sources, was given an $85 billion “bridge loan” by the federal government in exchange for what seems to be a good deal for the Treasury, 8% plus interest (currently about 11% as based on LIBOR), plus 80% ownership in what eventually remains of the company.
--Housing starts for August were at their lowest level in 17 years and with 4.7 million unsold homes still on the market, the inventory level has to fall considerably before homes are affordable again.
--Short-selling was banned in Britain until January, while in the U.S. the SEC banned it in 800 financials until Oct. 2 in an attempt to stem bear raids on the likes of Morgan Stanley and Goldman. As the veteran Jack Bogle put it Friday morning, the attempt to rein in the shorts “borders on insanity.” Far more on this next time as the rules are still evolving, which is a big part of the problem.
--There is a ton of revisionist history going on with regards to Hank Paulson. For now, understand your Fed and the Treasury, once seen as a lender of last resort, is today an investor of last resort.
--China holds $376 billion in Fannie and Freddie debt, Japan, $228 billion, in case you were wondering the real reason why those two agencies were bailed out….admittedly, a slight exaggeration, but not that much of one.
--State and local economies will continue to see their tax revenues dry up. And as one London trader put it, when it comes to high-rollers, “The bling is gone.”
--And two editorial opinions, for the archives and the record.
USA Today, Thursday
“To those who would like to see more punishment and less help meted out by Washington, we say: Be careful what you wish for.
“Executives who won fat bonuses by behaving in colossally stupid ways, investing in junk mortgages and willfully ignoring risks, deserve neither help nor sympathy. But that is not the point.
“Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson are not in charge of law enforcement, ideological purity or consistency. Nor should they pass judgment on the few in ways that could harm the many. Their job is to prevent a dramatic drop in lending, which would threaten the entire economy.”
“Perhaps Secretary Hank Paulson was right that AIG had to be rescued to avoid a broader financial collapse. We aren’t privy to what he and the New York Fed were hearing about AIG’s credit default swaps or its insurance ‘wraps’ for the commercial paper market; maybe unraveling those would have smashed the corporate debt market or caused a run on money-market accounts. So maybe he had no choice but to rescue the part of AIG that was a hedge fund wrapped around the world’s largest insurer….
“The danger is that we will get these financial melodramas every week, if not more frequently. Each one only frightens the public more and extends the panic. The two surviving big investment banks, Morgan Stanley and Goldman, continue to operate with enormous leverage yet profess to have enough capital to survive. That’s also what Lehman and AIG thought. Markets are also punishing Washington Mutual, the big savings bank, and Wachovia, the regional bank, with others to follow if housing prices keep falling.
“Sooner rather than later, the Fed is going to run out of money to pull off these government takeovers. Its balance sheet was designed to finance open-market operations, plus serve as the occasional lender of last resort for regulated banks. Its assets have long been mainly Treasuries or currency.
“Since last December, however, the Fed has made creative use of its discount window with the result that its balance sheet looks uglier all the time. The Fed has guaranteed $29 billion in dodgy Bear Stearns paper, opened its window to ever more colorful collateral, and as of Monday even agreed to accept equity. With its AIG stake, the Fed now owns an insurance company. By our calculations, the Fed has committed some $380 billion of its $888 billion in assets to these mortgage rescue operations. That’s nearly half. And yesterday the Treasury announced it will issue new debt to lend to the Fed, not merely to fund government operations.
“These are all taxpayer obligations, and as such they pull the Fed ever more deeply into political decisions that compromise its independence. The Fed has been pushed into that situation because Treasury lacks the legal authority for such takeovers (except in the case of Fannie Mae and Freddie Mac)….
“We’re told Treasury has a proposal ready to send to Congress [ed. Friday’s announcement], but that the Members have told Mr. Paulson they don’t want to see it until after Election Day. Mr. Paulson fears that if he does call for action and Congress refuses, then the contagion would be even worse. Well, how much worse can it get than a failure or two a week of a major financial institution? The sooner a resolution agency is up and running, the fewer banks will fail and the lower the ultimate cost to the taxpayer.
“Mr. Paulson ought to tell Congress that this authority is essential to stopping a panic, and that the need is urgent. If Harry Reid and Nancy Pelosi say they can’t do it until December or later, then they can take responsibility for the nationalizations to come.”
And so Congress is now working this weekend to prevent this from happening.
--Monday’s 504-point drop in the Dow Jones [9/15/08] was the largest since 9/11, but we then had rallies of 142, 410 and 368 points in the average, sandwiched around Wednesday’s sickening 449- point slide. When it was all over, the Dow was off just 0.3% to 11388, while the S&P 500 gained 0.3% and Nasdaq 0.6%. If you only looked at the final box score, you never would have known the real tone of the game. For example, the S&P’s two-day gain of 8%, Thursday and Friday, was its best performance since the aftermath of the 1987 crash. Meanwhile, the global rally over the same two days was the sharpest in 38 years as many markets on Friday registered their best point gains ever.
But in the case of the action against the shorts, the covering of whose positions created much of Friday’s advance, there was one universal cry as a finger was raised to Hank Paulson. “You’ve changed the rules in the middle of the game!”