Who's next??

Is the question topmost in minds of investors as the credit crisis has seen two of the largest investment banks in the US going under. What started out as a trickle, is now a flood as the credit markets have virtually seized up. There in lies an explanation to whats going on in the financial markets at the moment, its not a crisis of solvency but rather of liquidity.

The rate at which banks borrow short term funds have gone up massively. More alarming was the fact of the US Federal Reserve selling short term T bills to shore up its balancesheet. I am now beginning to wonder has the Fed bitten more than it could chew? Possibly these are the first signs of the US financial system crumbling under its own weight.

Global central banks seem to have realised the gravity of the situation and are acting swiftly to inject huge amounts of liquidity into the banking system, particularly the short term credit markets. Would other central banks have to sew together a bail out package for the US Fed? Though this thought seems audacious at present, the developments in the present crisis have surpassed crises in the past in terms of speed and magnitude. Times have changed and how...

The Federal Reserve has hinted at upping the ante with a view to rein in the present crisis, doubts still linger about the amount of ammunition the Fed has up its sleeve. The $ 85 billion bailout of AIG being a case in point. Though the move hasnt done much for market sentiment. The situation with AIG has increased systemic risks in a system, which has already been stretched to its limits or even beyond. The flight to safety seems to have begun, a major beneficiary being Gold which had the single largest gain in Dollar terms yesterday.

The credit crisis has now snowballed into an apocalypse which has altered the landscape of Wall Street forever. The present scenario on Wall street is akin to the Law of the Jungle i.e. the survival of the fittest. The survivors of the present holocaust will have an entirely new world unto themselves, the question is how many institutions can really survive the pain further.

Mad Mad West...

The credit for this title goes to my colleague Archana, who suggested the title the moment i said i'm going to update my blog. What a weekend it has been....our entire team was away in Kuala Lumpur, oblivious to the changing landscape on Wall Street. Though the problems with Lehman Brothers were well documented, the announcement regarding Merrill Lynch's acquisition by the Bank of America was a bolt of lightning from the blue.

Lehman's problems were heightened as the Fed refused to bailout the troubled investment bank. Reading a news item on Bloomberg sounded like a virtual obituary on Lehman, only one amongst four purely Investment banks in the US. The fall from grace for Lehman has been swift yet stunning. It typifies problems with the investment banking industry. An article in the Wall Street Journal made an interesting observation. It likened investment banking to a casino, in case a trader made a profit its the bank's profit if its a loss its the shareholder's loss.

In hindsight, it looks like the root cause of the whole subprime and subsequent credit crisis has been complacency and greed. Most of the banks made huge profits from structuring and selling complex derivative instruments related to the housing markets. The fantastic returns saw a complacency setting in, as it was believed the stupendous returns would continue. And what followed, well as the saying goes.... the rest is history. The crisis has shaken the financial sector to its cores.... more than $ 500 billion in write offs, three large US investment banks going under. The investment banks have become favorited whipping boys for the markets, well almost!! Apparently the pain isnt over as yet, there's more trouble in store ahead. A pointer to this fact is a concerted effort from Central Banks globally to boost liquidity. Earlier only the Federal Reserve, the European Central Bank and the Bank of England had boosted liquidity this time the banks of Japan, South Korea and China have joined in as well. Its an alarming sign, as the credit crisis seems to be spreading its tentacles globally.

The recent problems have seen global equity markets getting pounded, it seems like an orchestrated atmosphere of fear has gripped the global markets. Equities are not the only ones taking it on the chin, Commodities and the Foreign exchange markets have well and truly been a part of the massive readjustment in the markets. What next from here..... the picture doesnt look good at all, its almost like the markets have come full circle i.e. back to where it all started from. The turbulence witnessed in the markets recently looks like going on for a while longer. Looking at it on a contrarian basis, i believe this could signal the beginning of the end for the crisis, though its clear its way too early to get gung ho on the markets at this point.

Bear Stearns, Fannie, Freddie......Lehman???

The names seem familiar, as were the problems faced by the first three. Are we up for a repeat of the This was the first thought that came to my mind the moment I heard the shares of Lehman brothers plummeted 45% in a single trading session. The reason attributed to the massive slide was the failure of the Investment bank to conclude talks with a South Korean Bank for capital infusion. A possible capital infusion into Lehman had arrested the negative sentiment in the financials sector, particularly the investment banks which seem to have become favorite whipping boys for the stock market. Is Lehman on the verge of collapse?? Its really difficult to have an answer to this question, but going purely by the market movement of its stock something surely seems to be amiss. Things have really turned sour for Lehman, one amongst the four US entities which are pure investment banks, the others being Goldman Sachs, Merrill Lynch and Morgan Stanley.

While in a conversation with my Boss over Lehman a while ago, he pointed it out at times the markets serve as self fulfilling prophecies. Like in the case of Bear Stearns, the liquidity problems surged once other banks started refusing to lend money in the interbank market. Recently, there was news of officials from the Federal Reserve calling up Credit Suisse, a swiss bank to verify whether they had cut off credit to Lehman Bros.

Problems for the US economy seem to be only getting worse. The Treasury placed Fannie and Freddie under a conservatorship with a view to removing the ambiguity of the mortgages owned or guaranteed by the pair. These two entities combined either own or guarantee about $ 5 trillion in mortgages. The fresh set of problems with Lehman leaves me wondering whether the Fed is going to intervene again should there be an escalation of the problems. A precedent has been set in the case of Bear Stearns; however the options available with the Fed seem to be rapidly diminishing. They were able to stem the rut in the US economy by aggressively cutting interest rates; they have seemingly stemmed the systemic risks in the short term by placing Fannie and Freddie under conservatorship. But my worry is, has the Fed got enough ammunition left should another wave of problems hit the financials sector.

In my view, the next wave of problems could be from “prime” loans, or loans given to people with good credit records. Jamie Dimon, the CEO of JP Morgan, which reportedly has huge exposures to these loans had remarked recently the outlook for these loans is “terrible.” Though these problems may or may not materialize, one thing seems certain. The financials sector and the stock markets on a larger scale are not out of the woods yet. Just as things were slightly beginning to look up, we have a fresh wave of bad news hitting the markets. How the markets cope wit the latest developments would be an interesting thing to witness. As far as investors go, the pain experienced over the past 6-9 months is likely to linger on for a while. All we can do is wait and watch.