Bankruptcies and Bottoms

At 7:48 a.m. when I sent out an email, I guessed we could see a turnaround after what promised to be a bad opener. The Art Cashin pass/fail test was back upon us, with the popular averages sitting right above the January lows. We got the turn after the market plunged to begin the day, and the lows are still in place, although to think the market is out of the woods would be naive.

To repeat, the January intraday low for the Dow was 11,600 (11,972, +21 points today), and for the S&P 1270 (1283 close, -5 points today.)

The Federal Reserve has told us that they are backstopping whatever they need to, and it's hard to imagine a stock market rout when the cash is flowing.

Oil and other commodities were down a lot, as those markets went through their own deleveraging process. I had thought the dollar would have to rally for oil to fall (and that would come about by a lesser fed funds rate cut and/or an ECB rate cut), but oil led the way down, and I'm hoping the dollar will stabilize because of it. A stable dollar would go a long way toward stabilizing our financial market. I still like the valuation on the energy names. I just think the price of the commodity is well ahead of itself in the short run.

The Fed meets tomorrow and will reduce the fed funds rate, and it will be a battle of rumor vs. the Fed for the stock market. The rumor mill lost big today, even though it tried hard to destroy a lot of different names from Lehman (LEH - commentary - Cramer's Take) -- $31.75 close with a range of $34.91 to $20.25! -- to CIT (CIT - commentary - Cramer's Take) to MF Global (MF - commentary - Cramer's Take).

I have said that "these things" don't end with markdowns, they end with bankruptcies. Within a rounding error of $2, we had an equity bankruptcy in Bear Stearns. Such an event often proves to happen at the bottom.

Traveling the next three days. I will try to email a word or two in, but maybe not. Read "travel" as a drive to Vermont to ski for a few days.

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Numbers Look Good for JPMorgan
This blog originally posted at 12:30 p.m.

JPMorgan is buying Bear for $200 odd million. Lots of costs in the transition (up to $6 billion some say). But the equity on Bear's balance sheet is $11 billion, and the Fed is guaranteeing on a non-recourse basis $30 billion. This is a great deal for JPM.

The S&P financials were trading at 1.3x book on Friday (thanks Merrill for the stat.) I don't think we can look to the Bear valuation as a guide, but we can't ignore it either. In the 1989/91 fiasco, 25% of financial firms went away via consolidation, merger or failure (again thanks Merrill.) Look for a repeat.

Thank God you can count on some things to be consistent. As Bear was sinking this weekend and 14,000 jobs were put at risk and the financial system was stress tested like rarely before, Bloomberg radio reports that still Chairman of Bear, Jimmy Cayne, was at a bridge tournament.

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A Good Deal For JPM
This blog originally posted at 11:30 a.m.

We had mark-to-market and mark-to-model in trying to value the leveraged debt that sits on balance sheets. But we now know when leverage is combined with a lack of liquidity, you get mark-to-crisis, and this has no formula to guide you. It's whatever it takes to get the deal done with a gun at your head.

The Bear Stearns building is worth a lot more than $2, but not with a gun to your head. JPMorgan (JPM - commentary - Cramer's Take) got a good deal, maybe a great deal. The Fed is putting up $30 billion in non-recourse financing so, the way I read this, Bear's assets can go down by that amount before JPM is at risk. With the Fed as your "partner," that's a good deal.

The Fed has established another vehicle to get money into the system called the Primary Dealer Credit Facility (PDCF.) It's the first time since the Great Depression the Fed has loaned directly to non-banks. The Fed will cut the fed funds rate by 75 to 100 basis points tomorrow, as the need to halt the brewing crisis takes precedent over all else.

The markets opened down this morning, but I wouldn't be surprised to see a reversal later today, and, keep in mind, for every major crisis in U.S. history starting with Pearl Harbor, the markets have been higher six months after the event about 75% of the time. We will survive this.

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Closer to the End Than the Beginning?
This blog originally posted at 10:15 a.m.

Lola Jane's honorary uncle, Dougie Kass, is quoted in this weekend's Barron's saying that he has covered his short sales in the brokerage stocks, but remains short some banks -- Citigroup (C - commentary - Cramer's Take), JPMorgan (JPM - commentary - Cramer's Take) and Bank of America (BAC - commentary - Cramer's Take) over concerns about their exposure to consumer loans. You would do far worse than if you listened to Uncle Doug, but I wonder if the coming bad news on consumer loans isn't already priced into these stocks. We shall see.

To quote the article mentioning Doug, "At this point, a hearty dose of bad news is reflected ... Investors believe the U.S is in a recession. The housing market continues to weaken. Fears abound about the value of broker's assets ... some financial firms have fallen nearly 80% in the past year." But, opines the author, "The Fed has jumped into the fray with both feet," and "the great capital market deleveraging may be closer to the end than the beginning."

The Fed does meet this week, and while some rate cut is inevitable, the Fed should at least communicate they are aware of the dollar's plight. I feel the price of oil and the decline of the dollar are linked, and unless we defend the dollar, oil will continue to escalate. Coordinated action with the European Central Bank is required. I can only imagine the buzz of calls around the world. I'm hoping the Fed opts for a smaller rate cut and the dollar starts to stabilize.

One of the reasons I am not as worried as Dougie about the consumer loan burden is the fact that, while large, it is dwarfed by the mortgage debt which is in the process of being sandpapered. One of the papers over the weekend noted total credit-card debt is $950 billion, about the same as auto-loan indebtedness. Mortgages are some $11 trillion.

The big issue is the total amount of debt at something like 133% of disposable income. That's huge, and that's why we are in a slowdown/recession and the market is off. It's huge news, but not new news.

Visitors to Amsterdam's popular Vondelpark will soon be allowed to have sex in public according to new rules adopted by the city. Dogs will no longer be allowed to roam the popular park without leashes, reports "The Week" magazine. Something is wrong here...

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In Many Ways, Bear Made Its Bed
This blog was originally posted at 9:27 a.m.

"No man is an island, entire of itself..." John Donne didn't mean Bear Stearns (BSC - commentary - Cramer's Take) when he wrote that, but it's applicable. When Long-Term Capital Management failed in 1998 (see Roger Lowenstein's "When Genius Failed", a superb book), the NY Fed gathered the heads of the Families in a room and said figure it out, boys.

The hat was passed and, as I remember, about $300 million apiece was the ticket, and the system was saved. Except Bear Stearns. Bear walked out. The Bear has always been edgy. But when two Bear Stearns hedge funds failed in this credit cycle, and Jimmy Cayne, the CEO, was found to be playing bridge or golf while his section of Rome was burning, the company's fate was sealed.

Wall Street has a long memory. Bear had no friends. While it is true that in Wall Street terms, if you want a friend, get a dog, it helps to have "relationships." Cayne's indifference set Bear off "entire of itself," and when calls were made for help last week, there were no takers.

Alan Schwarz, the new CEO, is a competent, really good guy. But he had no institutional depth in this market, having been a banker his whole career. He probably has a golden Rolodex for investment-banking deals, but no relationships in this new world.

He also made a dramatic misstep. Walter Bagehot, the 19th century British financial journalist wrote: "Every banker knows that if he has to prove that he is worthy of credit, however good may be his argument, in fact, his credit is gone." (Thanks to the New York Times for the quote.)

That's why this will be a one-off situation. The WSJ had a good analysis Saturday on Wall Street's liquidity positions. On Nov. 30, Bear had $17 billion in cash and owed $102 billion via secured financings. The $102 billion were loans made by "counterparties" and secured by assets Bear had on its balance sheet. If those assets declined in value, Bear would have to put up more collateral, or margin. Turns out the cash reserve was insufficient, and, and this is the big "AND," the counterparties were no longer willing to make the loans, and the loans were all short term.

Lehman is a big bond player, like Bear, and was much mentioned last week as a firm that should be watched carefully. But Lehman (LEH - commentary - Cramer's Take) has a much larger pool of liquidity at hand. It has $182 billion in secured financings but only $28 billion come due in the next 12 months, and the firm has a liquid reserve of $35 billion.

While the cash is 19% of its total secured financings of $182 billion, similar to Bear's 17%, very little of the debt is due in the next year, let alone right away. Additionally, LEH has $60 billion in liquid assets that could be sold, and just last week closed a $2 billion UNSECURED credit line.

So, LEH has total liquid assets of close to $100 billion, or some 54% of its collateralized financings. This is better than Goldman (38%), Morgan Stanley (39%), and Merrill Lynch (34%), and those firms also have a more diverse business mix.

Lehman, and the other firms, have something Bear did not. They have relationships forged in the recent history of financial chaos, where they stood next to one another. Dick Fuld runs Lehman. He knows not just the other Family heads on Wall Street, but you can bet he knows the counterparties that Lehman has borrowed from.

If Fuld, or Blankfein of Goldman, or whoever, had to hit the phones, the calls would be answered. Bear and Cayne were never there for anyone else, so turn about was probably fair play.

What an interesting week it was. Bear liked to be a maverick, which is all well and good, but you better not tell too many people to screw off, and you better be on the job and not at a bridge tournament.

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Vincent Farrell Jr. is a principal of Scotsman Capital Management. Prior to joining Scotsman in April 2005, Farrell was chairman of Victory Capital Management of Cleveland and chairman of Victory SBSF Capital Management in New York. He was a founding partner of Spears Benzak Salomon & Farrell, which was acquired by KeyCorp in 1995. Vince held a variety of positions in his 23 years at SBSF, including chief investment officer, and he served as the portfolio manager on a number of the firm's largest client relationships. He is a regular guest on CNBC as well as other national print and broadcast media.

Prior to joining SBSF, Vince spent nine years at Smith Barney as a vice president, sales.

Vince graduated from Princeton University in 1969 and received his MBA from the Iona College Graduate School of Business in 1972.