The carnage continues across the world’s markets with some taking extreme measures to halt the decline. We have already discuss the short selling rules brought in by the SEC, making ‘naked’ short selling a crime which is hope to stem some racier market strategies.
Across in Russia shares suffered their steepest one-day fall in more than a decade on Tuesday, losing up to 20 per cent, as a sharp slide in oil prices and difficult money market conditions triggered a rush to sell.
The heads of the Russian central bank, the finance ministry and the financial market regulator met on Tuesday night for an emergency discussion on ways to halt the crisis. Margin calls forced domestic traders to liquidate positions and brokers pulled credit lines. At least one Moscow bank failed to meet payments.
The rouble-denominated Micex Index closed 17.75 per cent down, the sharpest one-day drop since the August 1998 financial crisis, while the dollar-denominated RTS index closed down 11.47 per cent, its lowest level since January 2006.
The interbank money markets are in chaos with money market rates climbing to 11 per cent, their highest since a mini-banking crisis in summer 2004.
Chris Weafer, chief strategist at Uralsib investment bank: “We’re in completely uncharted territory where the prevailing emotion is of fear and numbness. No one knows where this could stop”.
In London, ETF Securities said more than 100 of its AIG-linked exchange traded commodity funds listed on the London Stock Exchange were suspended on Wednesday, September 17. ‘It is our understanding that the London Stock Exchange has suspended electronic execution … But off-book trading will continue,’ the company said in a note on its website on Wednesday.
The listed ETCs were suspended because of problems with liquidity because many market makers have cut exposure to troubled insurer American International Group Inc, ETF Securities told Reuters.
On ETF Securities website they say “ETF Securities is in discussion with its market makers, Authorised Participants and the Exchanges (London Stock Exchange, Deutsche Bourse, Borsa Italiana and Euronext) to seek to have trading in ETCs issued by ETFS Commodity Securities resuming in an orderly fashion as soon as possible. AIG continues to honour all of its obligations under our agreements with them, including processing all creations and redemptions in the usual manner and paying all redemptions due on time”.
With all this chaos around many are saying that we have finally reached the point of ‘capitulation’ where stocks are being sold on fear, volumes are huge and volatility is high.
After capitulation selling, it is thought that there are great bargains to be had. The belief is that everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom.
I don’t know whether we are there just yet. It seems each day we have a new issue. Fannie, Freddie, Merrill, Lehman, HBOS and now Morgan Stanley and Wachovia… Many do not see the sense in Morgan and Wachovia and are viewing it with suspicion.
If volatility is something you enjoy trading in, you are never, ever, going to get a better time than now.
Archive for September, 2008
Carnage Continues But Have We Capitulated?
AIG Bail-Out – Regulators To Blame?
Here we go again, another bailout.
The U.S. government stepped in Tuesday to rescue American International Group Inc., one of the world’s largest insurers, with an $85 billion injection of taxpayers’ money.
It was the second time this month that the US taxpayer has reached into its pocket and put money down to rescue a private financial company. It was also the same reason; that its failure would further disrupt markets and threaten the already fragile economy.
Under the deal, the Federal Reserve will provide a two-year $85 billion emergency loan to AIG, which teetered on the edge of failure because of stresses caused by the collapse of the subprime mortgage market and the credit crunch that ensued. In return, the government will get a 79.9 percent stake in AIG and the right to remove senior management.
The move was similar to government’s seizure on Sept. 7 of mortgage giants Fannie Mae and Freddie Mac, where the Treasury Department said it was prepared to put up as much as $100 billion over time in each of the companies if needed to keep them from going broke.
The Fed said it determined that a disorderly failure of AIG could hurt the already delicate financial markets and the economy.
It also could “lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,” the Fed said in a statement.
All in all from what I have read and the understanding of the situation, it looks like this is a good move. AIG has many assets not directly tied up in the MBS market which will be sold to pay off the debt to the US taxpayer.
The White House said it backed the Fed’s decision Tuesday.
“These steps are taken in the interest of promoting stability in financial markets and limiting damage to the broader economy, ” White House spokesman Tony Fratto said.
“The administration is approaching an unprecedented step, but unfortunately we are living in unprecedented times. Hearing of these plans, you have to stop to catch your breath. But upon reflection, the alternatives are much worse,” said Sen. Charles Schumer, D-N.Y.
In a statement late Tuesday, AIG’s board of directors said the loan will protect all AIG policy holders, address concerns of rating agencies and buy the company time to sell off assets.
“We expect that the proceeds of these sales will be sufficient to repay the loan in full and enable AIG’s businesses to continue as substantial participants in their respective markets,” the statement said. “In return for providing this essential support, American taxpayers will receive a substantial majority ownership interest in AIG.”
Those with Lehman on their CV’s looking for jobs, will be wondering why AIG was given assistance and not them but AIG is a different kettle of fish. Lehman had assets, of course, but the vast majority of value in the company was wrapped up in its reputation and ability to do business. Any financial institution that has a problem with its cash flow and insufficient assets to justify a loan which could be paid back, are going to be in trouble.
AIG will, probably, be able to dispose of the businesses it has and pay this loan back pretty quickly.
The interesting thing, however, is that I have not seen an explanation of what happens when the loan is paid back. Does the US government keep the equity? One would assume therefore that long term this is a marvelous equity play for the US taxpayer when AIG and the wider economy recovers. Manchester United fans will also be pleased to know that their team is now sponsored by the US government..
With more than 74 million customers around the globe, AIG provides coverage for everything from cars to homes to businesses. And with more than $1 trillion in assets and more than 116,000 employees, this bail-out has wide reaching implications, and all in all it look to be a good move.
Regulation
This bail-out does bring us back to the moral hazard issue, but it also provides a perfect excuse for the government (whoever that may be in the upcoming elections) to bring in regulations like we have never seen before.
Personally, and those who read our comments will know, we are positive about the regulatory system in general. It does its job, however, over-regulation is an issue that is going to be lost in the scramble to have a law named after some senator. Which will, no doubt, be copied by the UK.
Our feeling is that regulation itself is partly to blame for the crisis we have seen. Not a failure of regulation, although that is part of it, but the over regulation, or should I say ‘overly costly’ regulation that prevents proper competition.
Consolidation
The financial service industry over the last 20 years has gone consolidation mad, to a point where huge organisations dominate the market and this is only getting worse. Barclays buying some Lehman assets and BoA buying Merrill are recent examples.
This consolidation of the industry creates financial behemoths capable of absorbing the huge cost of ever changing regulation. Small companies, who could perhaps offer a broader, more controllable solution to the issues in the financial markets, are being squeezed out, in our opinion, to the detriment of the industry.
Cost
From financial advisors who cannot afford to be directly regulated so they join big networks, to traditional stockbrokers whose margins are so thin, that it is hardly worth it, there is an inequality. Running a small stockbrokers will cost you £30,000 – £50,000 per annum in direct regulatory cost plus your compliance guy(s) who will be on a similar salary. Any brokerage that creates deals where they have higher margins than 10% are pilloried by the regulators and press alike.
Compare that to restaurants where the food we eat is marked up by at least 60% (a cup of tea/coffee, actually costs about 10p-15..do the math on that), and you can see that margins in the financial industry are not huge. The way to make the most of crappy margins is to get bigger, either more money under management a la hedge funds or consolidate….
More regulation, across the board, will kill smaller companies. Before this year, I am sure the regulators would have loved this. To be able to deal only with giant firms with hundreds in compliance would be a dream come true… we know that some of the biggest and oldest firms in the world could not be saved by compliance…
Solution
In our opinion, the regulators should look at a separation of the industry, a demerger of the giant companies into separate operating entities concentrating on one area.
Banks are banks, taking in and loaning out money. Trading houses trade, corporate finance houses do corporate finance, stockbrokers broke stock and insurance companies insure cars, houses, boats etc (not complex financial derivatives).
A simplistic view, I know,and it won’t happen but this would be easier to regulate. A regulator may pooh-pooh an idea like this but if the regulatory regime is so great, why are we in this mess? More regulation will cause more cost and therefore more consolidation until there is one ‘Uber-bank’ doing everything… that, to me, is a scary prospect.
Lehman Brothers Succumb To Natural Selection
It finally happened, Lehman Brothers, the US investment bank, has said that it intends to file for bankruptcy protection “in order to protect its assets and maximise value”. Consequently, expect the markets to tank on the news as potential ripples spread through the markets today.
Barclays Bank and the Bank of America pulled out over the weekend after the potential buyers said they were not convinced that Lehman, which last week announced a loss of $3.9bn in just three months, would be a good buy for shareholders, a not so subtle code for ‘they are in big trouble and we don’t want to take it on’.
As of writing the Dow futures are down 330 points, an ominous sign for the open of the Euro bourses and, obviously, the US.
The good news, if there is any, is that a Lehman collapse could trigger a shake up of the entire US financial system which has been stuck in the economic doldrums since the mortgage crisis hit more than a year ago.
“The US financial system is finding the tectonic plates underneath its foundation are shifting like they have never shifted before,” Peter Kenny, managing director at Knight Equity Markets in New Jersey, said.
“It’s a new financial world on the verge of a complete reorganisation.”
The US Federal Reserve and a banking consortium had already announced measures to offset a further credit crunch in the wake of a Lehman bankruptcy.
The consortium of 10 global commercial and investment banks had said earlier that it would provide $70bn “to help enhance liquidity and mitigate the unprecedented volatility and other challenges affecting global equity and debt markets”.
Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan Chase, Merrill Lynch, Morgan Stanley, and UBS, said in a joint statement that they had agreed to create a “collateralised borrowing facility” of $70bn, with each bank contributing $7bn, to help ease access to credit.
“These actions reflect the extraordinary market environment,” the banks said in a statement.
The announcement came moments after the US Federal Reserve announced new steps to ease access to emergency credit for struggling financial companies, by broadening the collateral to be used for central bank loans.
The end of bidding for Lehman prompted a rare emergency trading session on Sunday which market sources said was initiated by the US Federal Reserve with the aim of reducing risk associated with any Lehman bankruptcy.
The lack of a government guarantee to resolve the Lehman crisis is the main reason Barclays decided to exit the negotiations, according to a person familiar with the talks.
So far this year, the government has bailed out mortgage giants Freddie Mac and Fannie Mae, and saved Lehman rival Bear Stearns from going under by extending it cheap loans and allowing its forced sale to another rival, JPMorgan Chase.
Within hours of the collapsed Lehman talks, there were already reports of talks involving the takeover of Merrill Lynch & Co and the expected sale of assets by American International Group.
Bank of America announced early on Monday that it was to buy Meryll Lynch for $80bn – creating the world’s largest financial services company in the process.
Over the weekend Alan Greenspan, the former US Federal Reserve chairman, projected the failure of “other major financial firms” but added that this did not need to be a problem.
“It depends on how it is handled and how the liquidations take place,” he said on US broadcaster ABC.
“And indeed we shouldn’t try to protect every single institution. The ordinary course of financial change has winners and losers.”
The collapse of Lehman’s comes on the tail of the Fannie and Freddie ‘nationalisation’ and the Bear Stearns sale both of which have garnered criticism from certain quarters about tax payers dollars being used to bail out ‘greedy bankers’.
While F&F was, in our opinion, a crucial move need to protect the integrity of the US financial system, a bail out of Lehman’s may have been seen as the silver bullet for moral hazard. A bail out of too many of the banking institutions may have signaled that whatever problems you get yourself into the government would bail you out. This, though comforting for investors, may have paved the path to a worse financial crisis years down the road.
In our opinion, it is better to take the pain now and let this crisis run its course.
On the whole the philosophy of ’survival of the fittest’ has been the key to success of the financial system for a hundred years, to give too much downside protection at this stage in the cycle could spell disaster for years to come.
Nature has a way of cleaning out the biggest users of resources in a forest by creating forest fires. After the chaos of a fire dies down new trees grow, plants that could not get enough light and whose resources were previously sucked up by big trees flourish and another forest is born.
The sad truth is that these banks that are succumbing to the fires of sub-prime gorged themselves on profits, dominated the markets and they have now slipped up. Smaller firms now have the opportunity to bask in the light and a new financial forest will be born.
Sure, it is sad to see a bank with history go, but the words of the fictional ‘Gordon Gecko’ from the movie ‘Wall Street’ should be ringing in the ears of bank executives at the moment; ‘either you get it write, or you get eliminated’.
£100 from 1945 – 2006
Shame this chart only goes up to 2006 but it is an excellent view of the markets over this period and clearly show, that after all the troubles of the last 60 years trading is still the best way to make significant gains over the long term.
It shows the value of £100 indexed from 1945.
Invested in equities with dividends reinvested it would have been worth £125,243 by 2006. Investing in equities without reinvesting dividends would have reduced the payout to £8,342. Investing in gilts would have reduced the payout to less than half the initial sum; £49!
May give some perspective after the year we have had!
