Monday Morning Quarterback: War is Hell
Debt destruction is necessary, but it will pass.
"You cannot qualify war in harsher terms than I will. War is cruelty, and you cannot refine it; and those who brought war into our country deserve all the curses and maledictions a people can pour out. I know I had no hand in making this war, and I know I will make more sacrifices today than any of you to secure peace."
--General William Tecumseh Sherman
History is littered with battles that redefined the global landscape.
Anxiety built, friction manifested, conflict emerged and tensions reached a tipping point.
When diplomacy failed, war was declared.
And that is what we’re now seeing in the financial markets.
This isn’t something one would wish for.
Lives are being destroyed, fortunes lost and the world as we know it will never be the same.
It’s most certainly scary but it’s also nothing new.
War is hell, but it most often passes.
This is an incredible juncture in the history of financial markets, a rebalancing of risk as the cumulative imbalances that built since the back of the tech bubble come home to roost.
We’ve monitored them in Minyanville for the last six years, wondering aloud if they would self-correct as a cancer or a car crash.
That question is being answered before our eyes.
As we define the path to the ultimate destination of debt destruction and price discovery, it’s incumbent on us all to remain lucid.
Don’t get lost in emotion or buried in regret.
Operate in the now, with an understanding of the past and an eye towards the future.
As unpleasant as this process is, it’s a necessary step that must occur before a legitimate economic recovery could ever take root.
I’ve long said that to get through this, we must go through this.
We’re going through it now and as strange as it seems, that’s a positive development in and of itself.
Where to Begin?
Many folks awoke this morning confused as to why Bank America (BAC) would buy Merrill Lynch (MER).
The answer is simple—with Lehman Brothers (LEH) filing for bankruptcy, the derivative dominoes would have toppled directly towards Merrill.
This deal is akin to someone chasing a fuse furiously firing towards a pile of dynamite and stamping it out before it blows up.
It was a proactive step, at least in the context of the widespread denial that permeated since our government told us sub-prime mortgages were contained early last year.
What’s unclear is why they would pay a 70% premium, particularly when the Federal Reserve had a hand in the transaction.
To be sure, few organizations have the capacity to absorb properties at distressed prices and those that efficiently execute will be in a position to prosper when this period passes.
Bank is still digesting Countrywide Financial and it has substantial consumer risk through its 2005 purchase of MBNA.
While this shotgun marriage might make strategic sense on the margin, the outsized premium is the single, biggest overnight nose scrunch.
But Wait, There’s More…
We’ve long offered that the other side of socialization was a false sense of security and the perils of moral hazard. That’s an easy academic debate but it becomes prickly when experienced in real-time.
The death of Lehman Brothers, while tragic and sad, isn’t today’s root cause of concern.
There are hundreds of trillions of dollars in complex derivatives tying the global financial machination together. When a major player can’t pay its counter-party, the seeds of contagion are set.
In addition to the marriage of Merrill and Bank , other avenues of assistance have been explored.
The Federal Reserve widened the collateral it accepts—including equity—and increased the size of the Term Securities Lending Facility from $175 billion to $200 billion.
Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at email@example.com.
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