Monday, September 15, 2008

Storm Before the Calm?

As I sit and watch the markets in Tokyo, London, Frankfurt slipping lower in response to the extrordinary events of yesterday I admit it's going to take a while to digest. Merrill-Lynch? gone Lehman Brothers, gone. AIG teetering. Washington Mutual likely to disappear. The Fed taking unprecedented actions that are by its founding mandate, illegal.

The only person I know of who understands all of it is the fellow I overheard last Friday night at an art gallery opening. He was apparently a banker from some comments I heard. "This mortgage crisis is all hype from the news media. It's not that bad."
My wife was showing her paintings in the gallery so I stifled my, "are you out of your fricken mind?!", and said, "nice color in this one don't you think?"

The Fed has made some unprecedented moves that would only be made if they have looked into a very dark abyss and are urgently trying to figure out how to cross it. Much like the Long Term Capital crisis in 1998, a group of banks have put up $70 Billion of liquidity for a borrowing fund for brokerages to tap. The Fed has said it will accept equity collateral for direct loans to investment banks. (Illegal, but they can sort that out later.) Commercial banks can now extend liquid funds to their brokerage affiliates, contrary to the Federal Reserve Act of 1933.

It now appears that the entire broker-dealer model is broken. The ability of brokerage subsidiaries to acquire federally funded liquidity from their commericial bank parent companies puts the last to remaining serious brokers at a disadvantage. I expect Morgan Stanley and Goldman Sachs are in serious discussions to merge into a major banking entity.

In moments of uncertainty there is always turmoil and error, just as in moments of certainty there is turmoil and error. On this most confused day keeping a steady hand on the tiller is crucial and look rather than think.

John Barnyak