Credit the souring mood this time to Credit Suisse (CS), one of the bluest of the blue-chip European banking stocks, which reported a massive loss due to what it called "mismarking and pricing errors" by its bond traders. They may call it fraud or a boo-boo, but figure it's just their pained way of saying that they have been snared in the subprime debt-related liquidity mess, just like all of their more plebian rivals. Meanwhile, Lehman Brothers (LEH) this week also put one foot outside of the closet today, as The Wall Street Journal reported that it is likely to reverse its prior tactic of denial and soon report a rocky quarter due to mismanaged bets on commercial real estate loans and residential mortgages.
I seem to remember that back around 10 months ago, Lehman, Bear Stearns (BSC) and Merrill Lynch (MER) all said that while they had done a little business in mortgages, they were unlikely to even record much of a slowdown, much less losses. What a difference a year makes. It just goes to show that it's really hard to believe corporate leaders sometimes. It's not that they lie, which they do, it's that they are eternal optimists who never think anything bad will happen to them.
I'm all for optimism, but there must be more to it than just a hope and a wink. Much of the business model that brokers relied upon for profit growth over the past five years has gone away, and it is not coming back.
All those fancy debt instruments that were created -- the collateralized debt obligations, structured investment vehicles, variable-rate debt obligations, credit default swaps, etc. -- generated fees that were very high-margin and went virtually straight to the bottom line. To the extent that there are no more suckers to whom these things can be sold, the financial services industry will have to retrench, cut expenses, fire people and go back to their basic business.While there is nothing wrong with straightforward commercial lending and trading, they're slow-growth businesses now under the cloud of impending recession. Moreover, as the brokers scramble to fill the holes in their capital requirements left by multibillion-dollar losses, they are going to have to hoard as much money as possible -- and that means fewer high-margin loans to hedge funds and other customers. As a result, I don't expect a lasting recovery in the brokers anytime soon, as their real fundamentals are deteriorating just as briskly as their valuations.