Worse than We Thought

I logged on to Bloomberg tonight eagerly anticipating some brightly-wrapped gift from the Wall Street banks to investors. In the back of my mind, however, there was a nagging little voice which asked, "What if the Fed won't save Lehman because they stand too much to lose with the Treasury for MBS swap?" Granted, I don't know how much Lehman traded for Treasuries from the Fed, and also there haven't been any trades for months now. On the other hand, the total traded is over $400 billion. The Fed is on the hook now. The can't afford another bailout, and everyone else is out of money.

Well, almost. They can still manage to cough up $70 billion, probably to fund a facility to dump the worst assets into and provide fake bids for much of the rest of the investment banks' holdings. Here are the juicy details from Bloomberg:

The Federal Reserve widened the collateral it accepts for emergency loans to securities firms, helping Wall Street weather a Lehman Brothers Holdings Inc. bankruptcy filing.

A group of 10 banks that includes JPMorgan Chase & Co., Goldman Sachs Group Inc. and Citigroup Inc. separately formed a $70 billion fund to ensure market liquidity.

Oh, the magic "liquidity" word. What will the Fed accept now?

The Fed will now accept equities in the Primary Dealer Credit Facility, its program for lending cash directly to securities firms, in addition to investment-grade debt.

What remains to be seen is how much of this $70 billion is really coming from the Fed.

In other news, AIG is in trouble and needs to raise cash. According to the Financial Times:

American International Group, the US insurer, is seeking to raise $10bn-$20bn (£5.6bn-£11.1bn) in equity from buy-out investors that could include Kohlberg Kravis Roberts, Texas Pacific Group and JC Flowers, as part of an emergency plan to shore up its balance sheet.

AIG has also petitioned to be allowed to borrow from the Federal Reserve’s discount window.

Bloomberg is reporting that AIG is seeking a $40 billion bridge loan from the Fed.

American International Group Inc., the insurer struggling to avoid credit downgrades, is seeking a $40 billion bridge loan from the Federal Reserve as it tries to sell assets, the New York Times reported. The insurer has turned down a private-equity investment because it would have meant handing over control of the company.

Standard & Poor's said Sept. 12 it may downgrade AIG's credit ratings because the share declines may crimp the insurer's access to capital. A ratings cut may have ``a material adverse effect on AIG's liquidity'' and trigger more than $13 billion in collateral calls from debt investors who bought the swaps, the insurer said in an Aug. 6 filing. AIG has already posted $16.5 billion in collateral through July 31. A downgrade could also set off early termination of swaps that may cause $4.6 billion in payments,
AIG said.

Seems like everyone's lined up around the block asking the Fed for handouts. And why not? Where's the money going to come from? I really don't know what AIG is thinking here. The private equity companies know that their time has come and they will get their deals. AIG is toast.

They should have done the smart thing and taken the money and run while they had the chance. Just like Merrill Lynch. See "Bank of America Said to Buy Merrill for $44 Billion." Sweet. They just got out for $29 a share. The only problem is that's in Bank of America stock.

I guess that Merrill's CEO John Thain isn't taking chances at becoming another Lehman Brothers. See "Lehman Said to Prepare Bankruptcy as Buyers Withdraw."
I think most people don't understand how dependent on daily borrowing the investment banks are. They really can't last more than a few days once their funding is pulled out from under them.

Looks like Bank of America is following the "let's make ourselves too big to fail" strategy. In the process, they are diluting their equity by about 30%. It still remains to be seen whether they will honor Countrywide's debt. I don't think they will. While they're at it, why not keep the good parts of Merrill and default on that debt as well?

What remains to be seen:

Will this cause a market crash?

Will the Fed cut rates on Tuesday?

Will this move 30-yr Treasuries to a new high?

How will the still unresolved situation at WaMu play out?

What does this all mean? The futures markets are showing a 300 point decline in the DOW. So, tomorrow might be a good day to take some profit on financial shorts. We shall see. Other than that, I need to keep a very sharp eye out for trading opportunities that may arise. If the banks are raising $70 bil, that has to come from somewhere. Some of it will undoubtedly come from the Fed. Some of it will also have to come from the market. If Treasuries sell off - a real long shot, but anything is possible, I will buy some more. I expect that commodity stocks will get dumped again. I expect that there will be a general flight to quality. If the selling gets bad enough, I may look for a bargain or two, but bottom feeding in this kind of environment is very risky. The risk doesn't seem to have the appropriate reward.