BEING STREET SMART
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Sy Harding
When Will It End? September 12, 2008.
How much longer can Washington and Wall Street assure us that the latest action taken will be the last needed, to clean out the toxic waste from the implosion of the real estate industry, only to discover a few weeks later that even larger piles of green-glowing sludge remain?
Do we even remember the fear in the air in the summer of 2007 when it all began? Merrill Lynch threatened to seize $800 million of collateralized debt obligations (CDO’s) it was holding as collateral for loans it had made to two obscure Bear Stearns hedge funds. The hedge funds had defaulted on the loans. Merrill was going to seize the securities and sell them at auction to the highest bidder, in an effort to recover some of what it was owed on the loans.
No! No! Panic on Wall Street. A public sale would reveal how much the CDO’s had declined in value, perhaps even that there was no market at any price for them. That would force a chain reaction of write-downs by financial firms holding staggering amounts of such assets. As long as they could claim they didn’t know what the CDO’s were worth they didn’t have to reveal they had huge losses on their books. Merrill cancelled the auction.
The stock market, led by the financials, actually responded with a nice two-month rally to a new high in October. Such was the power back then of Wall Street’s assurances that the problems had been solved.
However, after the two hedge funds collapsed, the questions and demands began in earnest. What were CDO’s worth? What was the exposure of financial firms?
So banks and brokerage firms followed one another in announcing a write-down of the value of their mortgage-related debt, supposedly to market value or less, one-time hits that “cleared the way for a return to normal operations and profitability”.
Each time investors believed, and the market would strangely rally on most days when multi-billion dollar losses and write-downs by financial firms were announced.
But the first write-down was not the last after all. There has been no end to additional write-downs each quarter, increasingly decimating balance sheets, liquidity, and even the ability of some firms to survive.
Meanwhile, Congress, the Fed, and the Treasury Department, have poured hundreds of $billions of cash, easy loans, and even debt takeovers, into rescue plans.
But so far, rather than slowing, the train-wreck seems to be accelerating.
The bailout efforts have been so many only the most prominent are still mentioned. There was the emergency bailout of Bear Stearns in March, via the Fed-brokered sale of Bear to JPMorgan-Chase (for $10 a share and $29 billion of debt guarantees by the Fed). The Fed opened its discount window for loans, previously reserved for the use of the commercial banks under the Fed’s jurisdiction, to investment banks and brokerage firms. It agreed to accept the worst of the mortgage-related assets on their books as collateral, loaning the firms Treasury bonds in exchange, in effect taking the risky assets off the books of the financial firms and putting them on the Fed’s own balance sheet.
Investors believed that would surely end the problems. But still the multi-billion write-downs come each quarter. The credit-crunch and decline in home sales and prices continue to worsen.
A few months ago Washington added a couple of hundred $billion to the total of mortgages that quasi-government mortgage lenders Fannie Mae and Freddie Mac could guarantee. Wall Street and Washington assured us that by directly affecting the mortgage industry, that action would finally provide the support needed for the housing market to begin to recover.
Unfortunately, just a few weeks later it was discovered that the would-be rescuers were in need of rescue themselves, and Bernanke and Paulson rushed in again. The Fed said Fannie and Freddie could also use the Fed’s discount window, while Paulson made an emergency announcement extending Treasury’s credit lines to Fannie and Freddie.
But whoops! Last weekend came the announcement that Fannie and Freddie were within days of potential bankruptcy, and the Treasury department seized the firms. Their management would be ousted and they will be run by a government appointed conservator.
And now this week, Lehman Bros apparently moved into the lead car of the train wreck. Another Fed-brokered deal is expected over the weekend to arrange for Lehman Bros to be purchased by Bank of America and others, for a few dollars a share.
Already being whispered is that next in line might be Washington Mutual, or even Merrill Lynch?
Some day this will end. But don’t hold your breath waiting.
Sy Harding publishes the financial website www.StreetSmartReport.com and a free daily Internet blog at www.SyHardingblog.com. In 1999 he authored Riding The Bear – How To Prosper In the Coming Bear Market. His latest book is Beating the Market the Easy Way! – Proven Seasonal Strategies Double Market’s Performance!
