Monday, 15 September 2008

Yet Another Black Monday

Well this morning on Wall Street has been interesting, hasn't it?

Lehman Bros, an investment bank with $600bn of assets has declared itself bankrupt and is about to be dismembered by its fellow investment banks. Merrill Lynch, another large securities company, has sold itself to Bank of America - basically because it was bust. And American International Group Inc (AIG), the world's largest insurance company, has asked the Federal Reserve Bank for an emergency $40bn loan. That does not indicate sound financial health.

So what are the implications of all this?

Let's start with Lehman Bros. The feeding frenzy starts now. Lehman's has some valuable bits, eg, its asset management, and some toxic waste to the tune of $60bn in the form of collateralized debt obligations (CDOs) - basically mortgages which have been bulked and turned into a negotiable bond. Other banks will be trying to get the good stuff cheap, and the bad stuff even cheaper, if at all. Lehman's CDOs have a face value of $60bn but how much they actually go for in the open market will be very interesting indeed, perhaps as little as 20 cents in the dollar. The knock on effect here is that lots of banks are holding CDOs, often presented on their balance sheets with very optimistic valuations. (Provided you don't actually try to sell something you can claim it's worth anything you want.) This forced exposure to the market is going to crystallise valuations and could embarrass a fair few household names.

The other interesting factoid with the demise of Lehman Bros is that it has not been deemed by the powers-that-be as "too big to fail." Two "white knight" rescuers were on the stage last week: Barclays plc, and Bank of America. BoA rescued Merrill Lynch instead, and Barclays dropped out when the Fed refused to underwrite the CDOs. So if Lehman's is not too big to fail at $600bn then rather a lot of other institutions are not as well.

Note also that Barclays may not have been motivated in their rescue bid by sheer altruism, sorry, I mean profit. They were looking for Fed guarantees and an unkind take on their position would be: if Lehman's is too big to fail and we buy them with taxpayer guarantees then we'll be too big to fail as well. Perhaps Barclays have some bad news for us coming up.

Merrill Lynch: BoA has "merged" with them for £50bn. I guess that secures their future since Bank of America really is too big to fail.

AIG is still very much in play; so far they just want a short term loan from the Federal Reserve, just $40bn please guv'nor. Of course once the taxpayer is in the hole for $40bn it might be quite difficult to say no to further demands; prepare to see good tax dollars follow bad ones.

And for the future; who's next?

Well, in the US Washington Mutual has been teetering on the brink for quite a while now; and over here in the UK Alliance and Leicester and Bradford and Bingly are generally favourites for doing the next "Rock", but of course Her Majesty's government wouldn't let them actually go under.

On the markets generally today: the US$ is down; gold is up; oil is unchanged. Pretty much what you'd expect.

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