Monday, 17 March 2008 01:00

Additional points to look at as trading starts

One thing of note - The Fed's attempts to prop up the market should
help most banks, but the issue is that the bank's problems are that of
solvency and not liquidity. Liquidity problems have popped up, but they
are a consequence of the market being fearful of insolvency. The Fed
has created a limited backstop against general liquidity issues, but if
there is another run on the bank the Fed will not be able to afford to
stop it. Even if they could, they can't stop all of them by supplying
money. If there is a run on the bank, Lehman is next in line. I mention
this because if you really read my pieces - Banks, Brokers, & Bullsh1+ part 1
and Banks, Brokers, & Bullsh1+ part 2 you should walk away appreciating the risk between large private
investors and the I Banks. The I banks are starving for liquidity to
balm their solvency issues, so if they get money from the Fed you can
bet your booty that they will not be lending it back out (I was told that the banks were told by the Fed to allow their clients to borrow through them to the Fed window, but seeing is believing). They will
also be very jittery about collateral and credit risks, which means
more margin calls. The calls will be devastating. That means that if or
when banks start calling in collateral, the crash just may occur in the
hedge fund/private institutional investor arena before the actual I
bank arena. I that happens, the collateral will devalue futher as
deleveraging occurs, and it will put a liquidity strain on the I banks
again as they bang against the Fed's lending facility. I can't
guarantee this will happen, but it is a distinct possibility.

Last modified on Monday, 17 March 2008 01:00


  • Comment Link Mark Edmunds Monday, 17 March 2008 17:21 posted by Mark Edmunds

    For an operation with a strong, clean balance sheet with fresh, unencumbered capital, it seems like an excellent time to extend credit in a wide range of areas. In addition to wide spreads, I am guessing that limited supply of credit implies that lenders can be very choosy.

    Waiting to pick through the carnage will probably afford excellent opportunities, but is it fair to say that this is a "messy" process? Valuing a complicated balance sheet like any of the publicly held banks seems like a challenging task to say the least, and there is lots of potential for negative surprises. Even if you are able to "solve" the valuation equation, the market might not figure things out at the same time. It seems entirely plausible that one might purchase shares at 60% of the fair value of assets minus liabilities only to find that the market valuation drops by another 50% or more.

    Assuming one were astute enough to figure out when the market has bottomed, is it fair to say that stabilization is likely to occur at about the same time that spreads begin to narrow? If this takes a year or more (this seems entirely plausible from my admittedly ignorant perspective), it means a year or more that you would have lost out developing a business that earns attractive returns.

    As always, it will be great to hear your thoughts. I have probably said far too much on this topic already, given that I really don't have the foggiest idea what I am talking about. I plan to share some thoughts on a few other areas where I have a little more to offer.

  • Comment Link Reggie Middleton Monday, 17 March 2008 14:11 posted by Reggie Middleton

    Instead of starting from scratch, I would wait a while and pick assets from the ashes of this debacle.

  • Comment Link Mark Edmunds Monday, 17 March 2008 11:44 posted by Mark Edmunds

    Would it be a good time to start a new bank with fresh capital unencumbered by junky assets? The winners would be the new bank and the capital markets generally (maybe the capital markets won't win in form of gains, but the pain might be mitigated), and the losers would probably be existing banks.

    I will be the first to confess that I am a complete ignoramus when it comes to the banking business, so apologies if this comment seems like it comes straight from Mars.

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