‘Puter’s been doing some drinking and some thinking this past weekend, hence the dearth of posts. Both the drinking and the thinking are the direct results of the most recent financial news shaking out on Wall Street.
Lehman Bros. is as dead as a doornail. There won’t be a Chapter 11 reorganization, despite filing under that chapter, as there’s no funding, and no one except the gubbamint has the wherewithal to lend sufficient funds on good enough terms to keep Lehman liquid. The only question left is how painful the liquidation is going to be when the Court converts the filing to a Chapter 7. And make no mistake, it’s going to be painful, from the hit to employees’ stock options (already worthless) to the fire sale discounts that are going to be taken on Lehman’s assets (exerting further downward pressure on comparable asset values in the market). And that’s if the bankruptcy trustee (or debtor in possession) can find any buyers at all in this tight-fisted credit market.
‘Puter can’t really see through the fog on Bank of America’s acquisition of Merrill Lynch, because there’s not enough information yet. The acquisition seems a good fit, because both businesses focus on retail transactions. However, Merrill still carries significant balance sheet difficulties based on the inability to determine a market value for its CDOs and other securitizations. Bank of America has good management and good liquidity, but acquiring a failing, illiquid enterprise in a down market seems unwise, unless Bank of America plans to hold for the duration of this crisis. Also, the reserves Bank of America is going to have to take against Merrill’s losses should curtail to some degree Bank of America’s ability to lend into the market, further tightening credit.
Now AIG is in trouble, begging the Fed to open its discount window to keep it liquid. Here’s the rub. AIG is not your typical financial institution. It’s an insurer that got sucked into this mess by backstopping financial transactions for which it apparently misunderstood the risk. Coupled with presumed large losses from Hurrican Ike, things don’t look promising. This bankruptcy-in-waiting illustrates the problems with an interconnected financial market that parcels out risk to people and entities that do not have a full appreciation of that risk.
And Washington Mutual’s on the ropes, waiting in the wings for a capital infusion, buyout or bankruptcy.
‘Puter is reminded of some of the great financial debacles of his lifetime, from the S&L crisis in the 1980s, to the junk bond/Drexel Burnham Lambert issues in the 1990s, to the millennial Tech Bubble and Long term Capital Management problem, to today’s credit crunch. All stem from the same issue: misappraisal of actual risk. Interestingly, if you look at each crisis, the underlying financial structures were blamed for the failures, not the human misunderstanding. The existence of each of the underlying structures today exonerates the financial structure explanation, leaving the only possible explanation: human error.
‘Puter fears an even bigger risk this go around. Today we are on the verge of making the federal gubbamint the lender of last resort in every business venture. That is, when things go bad (which they always do) investors will have built in expectations that the gubbamint will bail them out. If the gubbamint takes this approach, it will eventually bankrupt the country. If there’s no risk to investors, investors will make bad decisions. See, e.g., easy abortions and easy divorce.
‘Puter’s prescription? To paraphrase Andrew Mellon, liquidation of bad investments is the only way to prevent moral hazard from taking hold. Liquidate, liquidate, liquidate.
Get to it, feds.