Monday, September 15, 2008

...In the end the love you take is equal to the love you make...

Perhaps the more common colloquialism is this, "what goes around comes around."

Lehman and Bear Sterns were two firm that previously had opposed participating in rescue package for the LTCM assets. Now both are gone... or at least going or gone.

Leverage anyone?
Lehman was very leveraged although I read some accounts that ask why this firm is going. It is not just the leverage you have but the stuff you leverage and if you remain fully exposed to what you carry without hedges. Think of it of lifting a weight. If it is on bar bell you can lift it efficiently. But if the same weight is the shape or a refrigerator it might be hard to get your arms around it...

So right it was wrong?
Leverage has long run amok in the markets. The Fed has been complaining of excessive risk taking and leverage for years. Is the Fed wrong to have been right? Should the Fed have put some muscle behind its mouth?

Did the Fox watch the hen house?
That is still a tough judgment. We, in the US, believe in less regulation. Over the past years with Greenspan at the Fed, it pushed a minimalist agenda of regulation. He preferred to have the market oversee itself. Well that's fine as as long as it's not the fox watching the hen house.

A new age...
Looking back that does not seem to be the case. It was something more subtle. The market overseers and the market participants seemed to have developed the same blind spots. They drank the same Kool-Aid. Those who warned about sub-primes and CDOs and the like were the gadflies of the financial markets and were swatted aside. The market was too hard-charging on a new agenda to be introspective. They thought it was a new age.

ROCKETMAN! The first church of Jesus without Christ
It is interesting to note that around the year 2000 one financial writer thought that the DOW was set to go to a huge number (30,000!) in part by giving it the multiple of a bond. He argued that we had reached a new age of 'stability' and that stocks were 'less risky'. And for a while as he wrote that crap he seemed to be on to something; maybe even right. But, of course, he really was wrong, very wrong. But even in the 'crash of the markets after that period this view of an inherently more stable financial system and of becoming the masters of risk though quantitative analysis continued unabated. We would become masters of our own fate though math and statistics...or so we thought.

NO accounting for taste..or 'screwpals'
There were some mis-steps along the way. Enron thought it could achieve Nirvana faster not using black box models or statistics but by a different form of numerology called accounting! Better living though numbers! But this, in time, revealed itself as simple fraud- or not-so simple fraud. Still, it was a sign that markets were still trying to get more blood out of a stone. And it was a sign that people 'on the outside looking in' were willing to believe that some could do the 'impossible.'

The best of the best of the best the worst
The men in black took a hit and then hit after hit. The best of the best of the best were wrong after being wrong after being wrong. Soon they were in the red and not at all in the black. In the end there was not enough capital to protect some of them. Some that rode that great tsunami of leverage saw the hard landing and got out before the wave crashed on shore. But most did not. The market could not. This is known as the fallacy of composition. What one may do not all can do. Goldman Sachs escaped, few others did.

It has been an eye-opening experience.

Rocket scientists on Wall street are reminded that economics is not simply mathematics. When markets are subjected to stress, long held relationships can do funny things.

So Lehman is gone. Merrill Lynch is being bought by BofA. BofA is now the Behemoth of America and is officially 'bullish on America', one of ML's most famous ad campaigns. AIG is trying to reliquify. Others remain troubled. Wamu is now the concern du jour or soon will be.

Gary Stern and FULD's FOLLY
As Minn Fed president Gary Stern warned in his book of several years ago, moral hazard attaches itself to the sort of assistance doled out to Bear Stearns. In the Lehman episode, though, the Fed said it was to be different. It vowed to use no public money. Treasury Secretary Paulson said the same. Still everyone on Wall Street approached the Lehman issue as one that would take on more public money. But the Fed held firm. In the end, Lehman became FULD'S FOLLY. The hard charging and bargaining CEO tried to squeeze too much value out of this firms assets at every turn and assumed the Fed would be there to bail him out, or assist. When the Fed stuck by its word to stay out of it no one wanted Lehman anymore. Result? The firm goes Chapter11and many people lose their jobs. It's a steep and sad price to pay for stubbornness and the unwillingness to believe the central bank. Stern had sketched out the risk over two years ago. Maybe if Lehman had done more reading...

An over-leveraged game of chicken
But once you step into the world of offering assistance as a central bank every one thinks like lawyers- you are making precedent. There is no belief in good Samaritanism or the simple practicality of the moment. There are no isolated cases. everything is precedent. In the end Lehman's moment did not have the same pressing urgency as Bear Stearns' moment. The Fed has many backstops in place that were not there at the time Bears Stearns became troubled. The crisis has become more mature. The Fed itself had bulked up its staff and become more specialized and able to handle the emerging problems. Lehman misjudged this in a game of over-leveraged chicken and now its gone. Lehman has become the new precedent that 'undoes' the old one..

It's capitalism not socialism after all
It's a lesson that will temper the behavior of all other firms in the market that now know that the Fed is not kidding. All the financing facilities are out in the open. Everyone knows the rules for using them. And now in the wake of the Lehman collapse, there is so little time. That is the new outlook for troubled firms that can now see they are in jeopardy. Before the Fed stood up to Lehman (or faced them down) there was a queue forming around the block at 33 Liberty Street as the next and the next weakest participants were lining up cup in hand. Now they are dispersed and and huddled talking in their own board rooms set to manage their own fate with a new grimmer view of reality. And as bad as it is. That's how it should be.

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