Philosophy over coffee

Long (Market) Update

In On Headlines, Size: Venti on October 16, 2008 at 2:43 am

And it’s another down day today. Surprise. Monday’s big rally, rising by 936.42- the biggest ever- almost got wiped out after yesterday’s drop of 76 points and today’s tenfold drop of 733.08 to 8,577.91. NASDAQ fell by 150.48 to settle at 1,628.33 and S&P also headed south by 9% to close at 907.84. Some facts: Monday’s rally is the biggest since the spring of 33 and last week’s more than 2000 point drop was the biggest since the summer of the same year. The volatility index, VIX, which basically reflects people’s fear of the market shoots up again to 69.25 after two days of hovering under 60.

People attribute the drop to two main things: hedge fund liquidation as well as the negative retails figured taken from the Fed’s Beige Book released earlier today. In this crisis, hedge funds are some of the biggest casualties and more of them are expected to go out of business in the coming days. As investors seek to get their money back, hedge fund managers scramble to take their positions out, in effect, creating an oversold market. Monday’s historic rise, people say, is still not the beginning of another bullish market. It was simply a bear rally.

With an oversold market, people saw the opportunity to buy again. Add to that the positive result that came out of the meeting of European leaders over the weekend- plans guaranteeing bank liquidity and interbank lending. People were also expecting a $250bn plan of the US government focusing on recapitalization and bank debt guarantees to be unveiled. Serving as the first tranche of TARP’s $700bn value, beneficiaries are: BofA, JP Morgan, Citi, Merill Lynch, Morgan Stanley, Goldman Sachs, State Street, Bank of New York Mellon and Wells Fargo.

Then there’s the report indicating that retail businesses have gone down in all 12 districts covered by the Fed report. Traders refer to the retail figures for September as a big killer of today’s market.

From the time I last blogged, Wall Street has witnessed a tremendous change. That time, just a week after Lehman’s bankruptcy, AIG’s government bailout and BoA’s acquisition of ML, things have gone worse and within the last 2 weeks alone, so much more have changed particularly in Europe, which is arguably bearing the brunt of this crisis heavier than the US. Here’s a quick list of what has been done by governments in and outside the US:

  • $700bn bailout plan by the US
  • Morgan Stanley and Goldman Sachs become bank-holding companies
  • Mitsubishi UFJ’s $9bn capital injection in Morgan Stanley. $7.8bn for convertible preferred at $25.25 and $1.2bn non-convertible. Both yield 10% dividend
  • Wells Fargo-Wachovia-Citi love triangle. WFC won. Citi decided stopped hoping getting the deal or part of it ($40bn worth of Wachovia’s deposits) but insists it will pursue legal charges for breach of contract.
  • JPM saves WaMu for a $1.9bn deal acquiring branches and deposits. This gives JPM access to a huge deposit base.
  • Days after LEH’s fall, Barclays acquires the bank’s North American operations including investment banking, fixed income and equities sales, trading and research operations. Nomura Holdings, Japan’s biggest brokerage buys both of the bank’s Asian and European businesses- in a span of 24 hours.
  • Gordon Brown takes the lead in presenting a comprehensive plan to help solve the crisis. The plan involves £400bn- £250bn for guarantees, £150bn for liquidity, and £50bn for direct injection to its biggest banks- Lloyd’s TSB/HBOS, Royal Bank of Scotland and Barclays.
  • Nationalization of Iceland’s three biggest banks: Landsbanki, Kaupthing, and Glitnir
  • France’s €360bn- €320bn for bank guarantees, €40bn for bank equity stakes
  • Germany presents €500bn- up to €400bn for bank guarantees and €100bn for additional support
  • Spain then pledges €100bn for bank guarantees while Italy will be issuing €40bn worth of treasuries for temporary funding.
  • And I’m sure there are more I missed.

After plans have been unveiled and days have passed, we are yet to see confidence come back to where it was before the financial crisis struck. Just a little over a year ago, the Dow hit its all-time high of 14,164. A year later, it hit its lowest in decades. It saw the biggest drop ever, even beating those that happened during the Great Depression. The guarantees are designed to thaw the frozen credit markets but there is still no guarantee that whatever banks receive from the government will be passed on for interbank lending. In tonight’s interview with Paulson, he dodged the question when asked how the government can guarantee that the money will be used for lending and not retiring the debts they are unable to meet due to liquidity problems.

While the plans so far unveiled do sound positive, a lot of people are still confused as to how these things would work. Specifically, there are still questions as to how the purchase of toxic assets will be done. The biggest issue, the pricing, remains unsolved. I believe that the Treasury’s shift from purchasing the assets to guaranteeing lending is partly a result of the urgency of things. Direct injections provide instant liquidity to banks, which is perhaps the biggest problem at the moment. However, the urgency to get rid of toxic assets remains intact and the Fed/Treasury would have to come up with a pricing mechanism as fast as they did with the bailout plan and the details of the first tranche involving $250bn.

Set aside the notion that this bailout creates the biggest hedge fund in the world or turns the US into a socialist state. It would be ideal if the government do not take stakes in these financial institutions, even as passive investors. Agreements have been reached and at the moment, what’s most important is for decisions to be made even when they’re not the most effective. Waiting a longer time would trigger far worse negative consequences in the markets. We don’t even know when “the most effective” solution would be reached. There will always be people who would play the devil’s advocate. I am against the principle that government’s intervene; I am for free markets and the invisible hand. But in dire circumstances like this, perhaps only the government has the power to do something about it. Because the very markets that I and many other rely on are just too weak and fearful to do anything.

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