Financial Sector In For Wild Ride
Landscape remains treacherous.
In my firm's final note of 2007, we commented:
"We have witnessed the brokerage and financial sectors report record losses yet amazingly, there have been no failures of firms of any stature. Sadly, there will be some failures because there needs to be. Otherwise, we risk turning into 1990s Japan, prompting investors to lose confidence in the entire financial system. Taking losses and clearing the slate is an important part of what makes capitalism work. This is not wishful thinking on our part, far from it. It is common sense and hope for the future. For those who find us overly pessimistic, we are reluctant bears who would like to be bulls."
I am deeply saddened to see such a statement come to fruition on such a large scale. We did not believe the current situation would culminate at this level. In our notes in recent days, we believed it was in the best interest of both the market and the Financial Industry to find a solution. It is hard to believe the powers that be finally found "religion" following a year of intervention at every hiccup.
As of 9 p.m., details of what the market is in for remain murky. Government officials appear to be working on some type of liquidity pool for bad assets. The Fed has also announced it will be taking equities at the Discount Window. Again, in response to a crisis, regulators weaken standards remarkably. If they are going to accept equities at the window, they might as well have simply written the check for one of the suitors. As it turns out, in this Trillion Dollar hand of poker that was played over the weekend, everyone was bluffing. It is being reported by the media that the day's lone piece of positive news - the Merrill Lynch (MER) acquisition - is a deal that was forced by the Fed. Now AIG (AIG) is looking to the Fed for a loan. Remarkably, the broad market itself closed in positive territory last week expressing little concern for the potential fallout of a "worst case scenario." The financial sector closed Friday 28% above its July low. Such disregard for potential risk is distressing. Even as the futures bumped around down approximately 2.5% last night, the market does not yet reflect the gravity of the potential situation.
The concern about systemic risk has been well advertised. While the night remains young, it is hard to see how the regulators should not be held accountable to a significant degree. We are a year into the cycle, and they already went through this drill in March. Questions will surface regarding the quality of the collateral that has been tendered to the Fed through the numerous programs and this continued easing of collateral standards. The drastic measures taken during the Bear Stearns crisis were supposed to prevent situations like the current crisis. In short order, there will be demands to see the marks on the Maiden Lane portfolio acquired from Bear as well. If the Primary Dealer Credit Facility is not drawn upon, then the obvious question already being asked is why? Is it symbolic as Treasury Secretary Paulson's "Bazooka" was intended to be?
In a market where potentially 3 of the top 5 brokers have disappeared in 6 months, it means that the landscape remains treacherous. There will be winners, especially the smaller Investment banks. From an index perspective, the financial sector, expecting an additional markdown tomorrow, once it occurs, has already incurred the majority of the damage it will experience during this crisis. The problems will be the reverberation throughout the economy as access to capital becomes even tighter than it already is. It appears that the amount of de-levering the market is about to encounter in coming months will likely outweigh the benefits of last week's GSE program. It is the real economy that is the concern from this point out, its eventual recovery will be delayed notably.
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