Reggie’s thoughts on financial mayhem coming into the week of October 5th, 2008

I’ve noticed a few queries as to my opinion of whether financial stocks will get better or if the worst is behind us. I actually thought I made my viewpoint clear. Obviously not, so let me be a bit more blunt. Things are going to get very ugly, starting this week – and from there it will get even uglier – and after that the bad part will start. Since I cannot predict the future I will shy away from X will happen in Y months, but the world’s credit and real asset markets are in a bad way and need a severe correction to reach a level of peaceful equilibrium. The central banks and governments appear to be dead set against letting capitalistic nature take its course, thus we will be in a tug of war akin to farmers trying to prevent tornadoes from destroying their crops. Best efforts may appear valiant, but in the end fruitless. Don’t mess with Mother Nature. I will put a post up in a few hours (partially free) that consists of the research that finally explains, in explicit detail, the industrial/manufacturing portion of my investment thesis and leads into the official global macro theme (it’s 33 pages and consumed a lot of resources at a very trying time, so the bulk of it will be for subscribers), followed by bankruptcy candidates that made it to the shortlists but were not selected for final analysis.

It is now time to move on to the 4th part of the thesis. Speaking of which, Asia and Europe are already trading down before the US markets open, and that is after the bailout that the supposed “market” wanted so badly and sold off because it didn’t get. In talking to some of my local congressmen, I noticed that they may have felt pressured in being blamed for a 777 point market selloff. I explained to them that the market is going to sell off whether they pass the bill or not, and particularly for the short term, it is a waste of thought to even try to placate a bunch of algorithmic, event driven or momentum traders. It will never happen. They need movement and volatility, not closure. The financial media is not a good source for investment knowledge!

The most recent US Bailout and its effects on what I have covered thus far 

The bailout plan is still (yes, even in its pork stuffed, modified form) destined to fail. That is assuming the goal was to save banks and levitate markets. The buying bad assets will help the big money center banks that have been taking marks, ex. Citibank, et. al. but will punish the regional banks, ex. the Doo Doo 32!

The Doo Doo 32 and related banks will either get crushed due to their lack of even remotely marking assets appropriately, or the government will scam us all by setting marks at a level so high that can only be described as silly. If the latter is the case, it would be a shame, for it would be more efficient for the government to simply give the money to the banks directly. As I have stated many time in the past, attempting to artificially resuscitate the dead 3 trillion dollar (or so) mortgage derivative and mortgage market is a fruitless endeavor with a mere $700 billion or so. Much or this paper was written with highly levered capital at the top of the biggest real estate bubble since the gold rush. It is highly improbable that property values will return to a level that will make much of this paper worth par values. Think about levering 30x to 1 on Yahoo stock in 1999, and then experiencing the dot.com crash the year afterwards. Now, just imagine selling a bunch of this stock to the government (at damn near any price) and the government waiting around to break even on that investment. Now think of how much stock and for what price, the government will have to consume in order to make you whole. Now, imagine that Yahoo had a $2 trillion or $3 trillion float. You have now wrapped your head around the Paulson, cum congress, bailout plan. Look out below!!!!

Capital, or the dearth thereof, is still the pre-eminent problem, and not only is it barely even touched by the gov’t bailout plan, it is exacerbated for entities such as the Doo Doo 32!

1.      This upcoming week will probably be nasty, and it will most likely get worse from there. Wednesday, the short selling ban (one of the dumbest ideas to come out of Washington in a minute) will be lifted and all of those banking (and related) stocks (again, Doo Doo 32!) whose share prices soared up to or close to their 52 week highs (while their economic conditions hovered around their 300 week lows) will be forced to face the piper. It should be ugly. See

The industrial/manufacturing sector will show bigger losses than the banks soon. 

It may be harder to manage bearish positions in the financials due to govt. intervention and bear market rallies that exacerbate already ridiculous volatility levels. I have heard this a lot from my readers, and even I had to cash in a lot of profits before they ran their course. Luckily, I have a longer term mandate than many, thus I always have  decent amount of capital stuck to my thesis, which has panned out in spades. This government induced volatility will have a price for those that it was intended to aid, though. The cost of equity and debt capital has shot through the roof.

Foreign capital will be much harder to come by, as domestic and foreign funds and SWFs tire of seeing their money flushed down the toilet mere hours after investing.

This is particularly true when it comes to changing fair value accounting and mark to market rules. Failure to aggressively adhere to these standards are really what got us to where we are now. Dismissing them in lieu of mark to fantasy will simply increase market opacity which will cause additional FUD (fear, uncertainty and doubt). We really don’t need any more of that now, do we? So, unless the banks and the government truly believe that we investors are stupid (and yes, some of us are), simply telling us that the sh1t on your balance sheet that couldn’t get a bid at 25 cents on the dollar last week is now worth $1.05 on the dollar (par plus) is going to do wonders for the financial entities already decimated credibility and levels of trust amongst each other. It will cause the market to tank even further, because companies that didn’t trust each other before are really going to be paranoid as the each of them perpetrates a government sanctioned lie and fraud. There goes the common stock value of the banks. There goes the industrials and manufacturers whose business model depends upon free flowing credit. There goes any hope of the housing market recovering within two to three years. Listen, whoever has the authority and inclination to do something constructive – It is too late to build upon additional lies. Expose the truth, let the most insolvent of the insolvent fail, and allow the strongest to feast off the ashes of their weakest brethren to rise again as the Pheonix of lore.

I was talking to a congressman, explaining that the only thing at will save the US’s stature in world finance is that the UK, EU and much of Asia and the middle east will fall harder, and faster with even less of a safety cushion (and we really did not have much of one).

RE: bailout package = $700 billion, Residential mortgage market (+derivatives) = $2 trillion, Commercial mortgage market = XXX billion, Leveraged loan market = $XXX billion , high yield market = $XXX billion, CDS market = $69 billion, + equity, commodity and various fixed income derivates, overvalued and illiquid real property and raw land =  $XXXX billion. This is what Paulson is going to need to unfreeze, not just mortgages and CDOs. Exactly what is this $700 billion supposed to do to liquefy these markets??? The better question is, at what price does one sell one’s credibility? The banks and lenders don’t trust each other, and they don’t trust their clients and customers. Can this trust be bough with $700 billion? I doubt so, but even if it could, the price has just went up with the reinstating of the Mark to Mythos method of unfair value accounting.

More on bank’s distrust of each other. The Timesonline and Bloomberg have broken stories on JP Morgan causing the collapse of Lehman by freezing $17 billion of its highly liquid assets over the weekend. JP Morgan was Lehman’s (and Bear Stearns) clearing bank. That means it was to act as custodian of these bank’s assets in order to assure their safety. It appears that JP Morgan was also a counterparty to the tune of about $23 billion as well. I hope we all realize the dangers in this conflict of interest. If true (most likely), JP Morgan is not only guilty of self dealing but has branded itself as untrustworthy as prime broker and custodian. Where do you think the big PM accounts of BSC, LEH, and MS went when they had runs? Ireland bolstered their weak banks by guaranteeing their bank deposits to a much greater degree.  This led to a literal drainage of deposits from neighboring UK and euro zone banks. Who trusts who? Multiple global bank runs?! And the banks you are running to may freeze your assets. This is the level of FUD in the air, and the US government is now bringing back mark to mythology accounting!!! Yeah, we’ll trust each other lot more now.

Here is an excerpt from one of Nouriel Roubini’s recent posts:

Yesterday Thursday a senior market practitioner in a major financial institution wrote to me the following:

Situation Report: So far as I can tell by working the telephones this morning:

  • LIBOR bid only, no offer.
  • Commercial paper market shut down, little trading and no issuance.
  • Corporations have no access to long or short term credit markets — hence they face massive rollover problems.
  • Brokers are increasingly not dealing with each other.
  • Even the inter-bank market is ceasing up.

This cannot continue for more than a few days. This is the economic equivalent to cardiac arrest. Then we debated what is necessary to restart the system.

I believe that the government will do another Hail Mary pass, with massive guarantees to the short-term commercial credit system and wide open short-term lending by the Fed (2 or 3 times expansion of the Fed balance sheet). If done on a sufficient scale this action will probably work for a while. But none of these financial measures affects the accelerating recession — which will in turn place more pressure on the financial sector.

Another senior professional in a major global financial institution wrote to me:

Today, in our trading room, I could see the manifestations of a lending freeze, and the funding hiatus for banks and companies, with libor bid only, the commercial paper market closed in effect, and a scramble for cash – really really scary.

Do you think this is treatable without a) a massive coordinated liquidity boost and easing of monetary policy and b) widespread nationalisation of some banks, gtess to others AND a good bank/bad bank policy where some get wiped along with their investors? The Treasury Tarp plan is an irrelevance if we are at a major funding crisis.

And to confirm the near systemic collapse of the system of financing of both financial firms and corporate firms Warren Buffett declared yesterday, as reported by Bloomberg:

the U.S. economy is “flat on the floor” after a cardiac arrest as companies struggle to secure funding and unemployment increases.

“In my adult lifetime I don’t think I’ve ever seen people as fearful, economically, as they are now,” Buffett said today in an interview with Charlie Rose to be broadcast tonight on PBS. “The economy is going to be getting worse for a while.’ …The credit freeze is “sucking blood” from the U.S. economy, Buffett said.

Now, a result is interbank lending is near non-existent, people and corporations are running from uninsured bank deposits and money markets in fear causing bank liquid capital to dry up and the commercial paper market (very short term private lending) is dead. I have listed and supplied analysis/models for 4 companies above $15 who are very susceptible to both short term and long term debt rollover to be published in the macro write up that I will post in a few hours. As you read the free portion, notice the recent drop in prices.

Hopefully, now you realize that the government’s buying of MBS etc. Will do near nothing to solve this capital/liquidity problem, and neither will lying about their value via mark to mythos accounting. If anything it will get worse, much worse (the plan may be designed to do just what I suggested earlier, save a few slightly insolvent banks by feeding them the very insolvent banks). This situation has been exacerbated by Commissioner Cox’s banning of short sales which have made the companies least deserving of higher share prices (those most widely seen as a victim of the times) rise the most as short seller pressure suddenly stopped and momentum traders ran these stocks up without the natural checks and balances of our capitalist stock market was intended to provide. Now when those checks are allowed to come in place again, the bust portion of the boombustblog will have tangible meaning.


Originally published at Reggie Middleton’s Boom Bust Blog and reproduced here with the author’s permission.