Thursday, September 18, 2008

Has The World Markets Gone Kaput?

The signs out there are terrible!

On CNBC website Nowhere Near Capitulation Yet ...


Is this doomsday or what?

Everyone is shouting that this is the worse crisis yet,
Worst Crisis Since '30s, With No End Yet in Sight and ECB doyen Otmar Issing calls crisis "extremely dangerous"

And then you have Michael Lewis commenting this on Sept 15th:
This Is the Day Asian Capital Woke Up

  • According to the bankruptcy papers thrown together over the weekend, the list of Lehman's 30 biggest unsecured creditors is dominated by Asian financial institutions: Aozora, Chuo Mitsui Trust, Sumitomo Mitsui Financial, Mizuho Corporate Bank, Shinkin Central Bank, Bank of China and so on.

    Who else did you imagine would be left holding this bag? Who else did you imagine was propping up the system?

    Ever since the government jumped in to bail out Bear Stearns Cos. -- and whatever else that was, it was a bailout -- the behavior of the U.S. government in the financial markets has felt like a mystery by an author who is cheating and withholding a key piece of information.

    In letting Lehman fail the federal government puts a fine point on an obvious question: Why didn't they let Bear Stearns go, too? This business about the markets having time to adjust to Lehman's problems is baloney. The markets didn't adjust to Bear Stearns collapse; the markets looked at what the Fed had done for Bear Stearns and assumed they'd do it for Lehman.

    Unfounded Fears

    One part of the answer is that the people who sit on top of our financial system simply didn't know what would happen if a big Wall Street firm went down. They have since studied the matter and concluded that their worst fears were unfounded.

    But in Lehman's list of creditors we have another part of the answer, I'll bet. It wasn't merely instability the U.S. Treasury and the Federal Reserve feared. It was the loss of the good opinion of the people who supply the U.S. with the capital it no longer generates itself. For 25 years Asian financial firms have been amazingly indulgent of U.S. investment bankers.

    What do you think they're saying about them -- and us --now.
And it's no wonder that Asian markets are being hit bad, especially Hong Kong. This morning Raw Fear Slams Stocks, Hong Kong Plunges 7%

And the Russians aren't doing so good either.
Russia's Stock Market Woes

  • STRATFOR - The Russian markets plunged on September 16 before government authorities halted trading on the exchange an hour early; the MOSCOW Interbank Currency Exchange fell 17 percent, and the dollar-denominated Russian Trading System (RTS) fell 12 percent.

    The carnage built upon ongoing losses in the Russian economy that have now seen the RTS fall by nearly 60 percent since its mid-May highs. The Russian ruble has recently become the world’s worst-performing major currency.

    Russian government officials insist that this is simply a passing storm that has nothing to do with the August invasion of Georgia. While obviously an overstatement, there is something to the claim. Western financial institutions — and investment houses specifically — currently are engaged in a flight to quality investments. Russia, despite its ongoing impressive energy and minerals exports, simply never made the list of the top tier of reliable assets.

    But the fact remains that investors — and especially foreign investors — are scared. They were already nervous about the Kremlin’s flagrant targeting of foreign assets, and now the Russian willingness to invade its neighbors is most certainly a factor, as is the falling price of oil (Brent crude pushed below $90 a barrel Tuesday). Yet while the Russian stock markets are suffering because of the uncertainty, Russia is not necessarily suffering.

Chris Perruna's charts comparison of Shanghai and Nasdaq is most interesting, Shanghai is a Nasdaq Déjà vu

And the following webpage on NYTimes shows the extend of the damages:

So is Wall Street kaput?

  • Wall Street as we know it is kaput. It is not just that Merrill Lynch agreed to be purchased by Bank of America or that the legendary investment bank Lehman Brothers filed for bankruptcy or that the insurance giant AIG is floundering. It is not even that these events followed the failure of the investment bank Bear Stearns or the government's takeover of Fannie Mae and Freddie Mac, the largest mortgage lenders. What's really happened is that Wall Street's business model has collapsed.

    Greed and fear, which routinely govern financial markets, have seeded this global crisis. Just when it will end isn't clear. What is clear is that its origins lie in the ways that Wall Street -- the giant investment houses, brokerage firms, hedge funds and "private equity" firms -- has changed since 1980. Its present business model has three basic components.

    First, financial firms have moved beyond their traditional roles as advisers and intermediaries. Once, major investment banks such as Goldman Sachs and Lehman worked mainly for their clients. They traded stocks and bonds for major institutional investors (insurance companies, pension funds, mutual funds). They raised capital for companies by underwriting -- selling -- new stocks and bonds for the firms. They provided advice to corporate clients on mergers, acquisitions and spinoffs. All these services earned fees.

    Now, most financial firms also invest for themselves. They use partners' or shareholders' money to place bets on stocks, bonds and other securities -- so-called "principal transactions." Merrill and other retail brokers, which once served individual clients, have ventured into investment banking. So have some commercial banks that were barred from doing so until the repeal in 1999 of the Glass-Steagall Act of 1933.

    Second, Wall Street's compensation is heavily skewed toward annual bonuses, reflecting the profits traders and managers earned in the year. Despite lavish base salaries, bonuses dominate. Managing directors with 15 years' experience can receive bonuses five to 10 times their base salaries of $200,000 to $300,000.

    Finally, investment banks rely heavily on borrowed money, called "leverage" in financial lingo. Lehman was typical. In late 2007, it held almost $700 billion in stocks, bonds and other securities. Meanwhile, its shareholders' investment (equity) was about $23 billion. All the rest was supported by borrowings. The "leverage ratio" was 30 to 1.

    Leverage can create huge windfalls. Suppose you buy a stock for $100. It goes to $110. You made 10 percent, a decent return. Now suppose you borrowed $90 of the $100. If the price rises to $101, you've made 10 percent on your $10 investment. (Technically, the price has to exceed $101 slightly to cover interest payments.) If it goes to $110, you've doubled your money. Wow.

    Once assembled, these components created a manic machine for gambling. Traders and money managers had huge incentives to do whatever would increase short-term profits. Dubious mortgages were packaged into bonds, sold and traded. Investment houses had huge incentives to increase leverage. While the boom continued, government remained aloof. Congress resisted tougher regulation for Fannie and Freddie and permitted them to run leverage ratios that, by plausible calculations, exceeded 60 to 1.

    It wasn't that Wall Street's leaders deceived customers or lenders into taking risks that were known to be hazardous. Instead, they concluded that risks were low or nonexistent. They fooled themselves, because the short-term rewards blinded them to the long-term dangers. Inevitably, these surfaced. Mortgages went bad. The powerful logic of high leverage went into reverse. Losses eroded firms' tiny capital bases, raising doubts about their survival. This year, Lehman lost nearly $8 billion in "principal transactions." Otherwise, it was profitable.

    How Wall Street restructures itself is as yet unclear. Companies need more capital. Merrill went to Bank of America because commercial banks have lower leverage (about 10 to 1). It seems likely that many thinly capitalized hedge funds will be forced to reduce leverage. Ditto for "private equity" firms. In time, all this may prove beneficial. Financial firms may take fewer stupid and wasteful risks -- at least for a while. Talented and ambitious people may move from finance, where they were attracted by exorbitant pay, into more productive industries.

    But the immediate effect may be to damage the rest of the economy. People have already lost their jobs. States and localities, particularly New York City and New Jersey, that depend on Wall Street's profits and payrolls will face further spending cuts. Banks and investment banks may tighten lending standards again and impede any economic recovery. The stock market's swoon may deepen consumers' pessimism, fear and reluctance to spend. There may be more failures of financial firms. It's hard to know, because financial crises resemble wars in one crucial respect: They result from miscalculation.