The Night of the Living Dead

We face the specter of the ‘night of the living dead scenario’ where there are hundreds if not a thousand financial institutions are operating today – but are dead if mark to market accounting was applied to their assets.

In years to come, the real story will not be the subprime crisis or some housing bubble, it will be the spectacular failure of risk management systems in our, so-called, leading financial institutions.

 

Once bitten by LTCM in 1998, twice bitten by the recent crisis. How many bites does it take for firms to fix their risk management systems? You are supposed to plan for events (even if they seem remote) like the current one and have systems in place to survive – not to blow up.

The uncertainty is not just driven by Lehman or Merrill or even AIG or Washington Mutual.  People reasonably wonder about hundreds of other financial institutions and whether they are solvent.

In the usual global ‘flight to quality’, people pile into U.S. Treasury bonds. Global investors have realized that the risk of the U.S. has sharply increased. It is no longer the obvious safe haven.

Maybe the Treasury thinks it has simply bought some more time with Lehman and Merrill. The delay game can have massive negative consequences. Uncertainty causes liquidity to dry up making it very difficult for businesses, consumers and homeowners to get credit. No credit means no growth and no jobs – simple.

We want to get this over with as soon as possible – and it is naïve to think it is over after the last few days’ events. In the early 1990s, Japan tried the gradual approach to dealing with its problems – and it cost them 10 years of recession – a mistake that we should learn from.

 

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On Bank of America’s announced takeover of Merrill Lynch

They paid too much for Countrywide and now it seems like they are overpaying for Merrill Lynch. Merrill is badly exposed to AIG. It is no surprise that S&P downgraded Bank of America bonds today and put them on negative watch.

Just as JP Morgan’s announced deal for Bear Stearns was adjusted after the fact – I expect the Bank of American deal for Merrill to be changed. It seems unlikely that it will go through at $50 billion.

Why would BofA pay a premium for Merrill? There must be some quid pro quo with the Fed that we don’t know about. My guess is that they have been promised some regulatory relief that pertains to their size.

 

 

 

 

 

 

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